Debt allows businesses to access the resources to foster expansion, ultimately providing them with the means to do what they do best and solve problems within the community.
In recent times, access to funding has become an increasingly difficult task for SMEs in Australia. Prudential changes to the regulatory framework, a tightening following the Royal Commission, and a general risk aversion by the big four banks has effected a vacuum in this space.
Currently one out of every four requests by small to medium businesses for a loan is rejected by the big banks. Only 4% of the big banks’ commercial commitments are for under $100,000, despite the average loan size for SMEs being $50,000. As such, it is becoming increasingly difficult for SMEs to access funding via the traditional route without physical collateral.
Filling that vacuum are online lenders. With insatiable market demand and a lack of feasible SME lenders, FinTechs have significantly disrupted the market in recent times. However, it is important to recognise the real strata between those that are price gauging and unethical, and those that are reasonable and actually catering to SME needs.
With a lack of competition and limited access to wholesale funding, many FinTechs are now displaying truly predatory behaviour charging exorbitant interest rates and fees. Consequently, it is more important than ever to understand and compare lenders before accepting and choosing a lending facility.
The first step is always to calculate the real interest rate. Very often, lenders will advertise interest on a per annum basis as opposed to the real interest rate. This is particularly common for inventory and trade financing. These types of financing offer fixed fees on a short-term finance facility, which often results in exceedingly high real annualised interest rates.
For example, an SME could employ a trade finance provider to finance a $10,000 inventory shipment, with the agreement that the SME repays $11,000 in total. However, the payment terms may only be 90 days, in which case, the SME’s effective interest rate is in the order 40%.
As such, long-term debt options are often far more economical than short-term trade finance where significant costs are imposed. It is absolutely crucial when taking on debt that SMEs calculate the real interest rate applicable to their facility and consider if this is the most effective facility available.
The second consideration must always be additional fees and charges involved. When seeking debt finance, it is imperative to understand all costs, especially those related to unexpected events. When taking out a loan, people tend to be of the mindset that no problems will arise.
However, we all know that when it comes to business, you never know what is around the corner. So, you need to be prepared for cash shortfalls and what late payment scenarios would look like.
SMEs are often attracted to the ease and efficient processes of FinTechs. As a result, businesses are often not aware when their FinTech provider starts direct debiting their account for late payments. Late fees can be charged on a daily basis without the customer knowing, often resulting in hundreds of dollars in additional fees.
Bromleigh had one applicant whose loan balance with another FinTech provider had doubled because they hadn’t realised their direct debits were bouncing for two weeks. It is therefore imperative to have a comprehensive understanding of all terms, rates and fees in your contract. Common additional fees can come in the form of late fees, establishment fees, cancellation fees, and early repayment fees.
It is also important to watch out for third party fees. In many cases there may be an intermediary involved, such as a broker or affiliate platform. Often these third parties are accompanied by additional fees which may or may not be incorporated into your interest rate. My recommendation is to find a provider with no or low fees and to always request a schedule of fees before committing to a facility.
My final tip is a simple one: don’t overstretch yourself – start small and scale up. Businesses often go for what they think they’ll need in the future rather than what’s appropriate for right now. In my experience, it is always better to start small and look to increase your facility when you actually need the additional capital.
Borrow low and get comfortable with the interest, then grow the facility as your business grows. Good financiers will let you scale up rather than forcing you take a large amount out all at once. It is always best to build a good track record with your payments and increase your principal later, rather than stretching yourself initially.