Why 2016 Should be the Year of Sustainable Finance
As a former banker, I know from experience that the most common and trusted source of finance for entrepreneurs and small businesses is still a bank loan.
Around 62% of European small businesses rely on traditional debt for all their financing needs. Yet, as a recent OECD white-paper suggests, bank loans are not the most suitable way forward for all of these businesses at every stage of their life cycle.
In fact, another loan might not be the solution at all.
Why? Two main reasons.
Firstly, debt financing (business loans) can lead to a "financing gap" in the life cycle of some start-ups and small businesses. This is a major issue for newer, more innovative, faster growing businesses. These kinds of businesses often need to finance new projects that have high potential for growth, but also unpredictable profit forecasts.
Ultimately it's harder to predict if and when some ventures will start making money and enable the business to repay the loan. This makes it tricky to get a loan at a reasonable interest rate, whether at the bank or elsewhere. This problem is particularly serious for small businesses whose business models rely on intangible assets, such as intellectual property, copyright and brand awareness.
If a loan is granted the underlying problem is not necessarily resolved, just delayed.
Secondly, taking out loan after loan does nothing to improve a businesses's capital structure. Indeed, there's a longstanding need for small businesses to improve their capital structures. This became more urgent after the 2008 financial crisis when many small businesses borrowed more money to stay afloat. In some cases this only meant more debt, more guarantees and ultimately a worse long-term cash position.
The problem here lies in the nature of using debt to finance growth. A loan does not always offer a long enough financial runway for small businesses to grow, make a profit and start repayments. Then, when the time comes for refinancing, banks are less inclined to lend more money due to outstanding debts and a poor capital position. If a loan is granted the underlying problem is not necessarily resolved, just delayed.
Traditional bank lending simply can't keep up - especially in the aftermath of the 2008 financial crisis.
With a growing toolbox of financing options available to entrepreneurs this no longer needs to be the case. Alternative finance offers small businesses the chance to press a financial 'reset' button with asset-based, equity or hybrid financing. Selling equity, for example, provides growth capital without the debt and strengthens a company's financial position. This way, entrepreneurs can prevent the bank from having to say "no" when the time comes for a loan.
Clearly, the financial situations of many small businesses in the ultra-competitive digital age are more specific and unique than ever before. As the OECD white-paper confirms, traditional bank lending simply can't keep up - especially in the aftermath of the 2008 financial crisis. Meanwhile technologies like equity crowdfunding are, for the first time, enabling smaller businesses to sell equity online instead of taking out another loan.
In 2016, thanks to the rise of alternative finance, entrepreneurs will have access to a bigger financial toolbox than ever before.
With just a small change in mindset, we can start building for the future instead of adding more layers of debt.