Alexei Garan, Head of Business Funding at Shaw & Co, explains why SMEs may not be getting truly independent advice from their brokers when trying to secure growth funding.
For SMEs there are a bewildering number of funding options out there. As well as the traditional lenders, there is a burgeoning alternative lending market offering cashflow lending, growth funding, leveraged MBO and acquisition financing debt products that range massively in cost of interest, tenor, principal repayment structures, debt servicing, fees, personal guarantees and equity/warrant requirements, not to mention a range of many other features.
Of course, we’re not suggesting that brokers are anything other than honest. The point is that the brokerage process rarely provides SMEs with the widest possible view of all the available funding options. Here’s four reasons why:
By the very nature of their business model, brokers are incentivised to fulfil a funding requirement with the minimum number of lender approaches and, ultimately, the minimum number of lenders. Not only does this enable them to move swiftly on to their next client, and therefore their next sale, it also greatly reduces the complexity of a deal.
As brokers are typically remunerated through lender commissions, it is impossible for a SME to know whether the deal on the table is actually the best one available, or simply one from a lender that a broker has a commission arrangement with. Subsequently, a broker is also incentivised to convince the client that the terms on offer are attractive and to argue that any unappealing lender terms, such as ‘Personal Guarantees’ or ‘Equity Dilution’, are completely bearable or even ‘market standard’.
In the vast majority of cases, brokers are operating in competition with other brokers and often a SME’s own efforts to source funding. This means that brokers are incentivised to obtain a set of terms and represent it to the client as soon as possible, to have a chance of the client accepting the deal and to ‘own’ a lender connection for that specific client requirement. Obviously, this doesn’t incentivise brokers to prepare a client properly for the market or maximise the number of options they source so the client can have little confidence that they are seeing the whole market and truly picking the best deal. Moreover, lenders in this context can only gain a limited understanding of a business and are incentivised to make cautious offers, if any. Any opportunities not taken up quickly are discarded as the broker moves on to the next one.
In contrast to a coherent process where all relevant lenders are working to the same timeline, a brokered process can often stretch. This is because lenders are asked to show terms as soon as possible to avoid being beaten by someone else. As a result, clients usually receive a series of unattractive or inadequate offers from lenders who are not incentivised to ‘put their best foot forward’. We often see cashflow pressures becoming quite acute in these types of processes, forcing businesses to eventually accept terms on a deal that they would otherwise have rejected, with consequences such as significant equity dilution or a much higher cost of borrowing.
Subscribe to receive news updates, Connected Magazine, details of forthcoming events, opinion and industry topics that matter to you, and more.