The real cost of business finance

Exposed:

The

real

cost of

business finance

Award-winning finance journalist Emma

Lunn lifts the lid on the SME lending

landscape, revealing the hidden costs you

need to watch out for – and guiding you

through the maze of options on offer.

Contents

1.

The business finance landscape – an overview

3

2.

Making sense of your options

8

3.

Identifying the hidden costs

21

At the Federation of Small Businesses’ recent National Conference in Birmingham, politicians including David Cameron made keynote speeches which placed small- to-medium-sized businesses (SMEs) at the heart of the UK’s economic future growth.

Key challenges highlighted by businesses at the conference included late payments by suppliers, red tape, the lack of access to finance and its high cost. Tightening credit policies from banks mean that it’s increasingly difficult for SMEs to borrow money or attract investment, and traditional lenders are still not lending to businesses on a scale that meets demand.

In fact, research last year by the peer-to-peer lender

rebuildingsociety found that 31% of SMEs that applied for a bank loan were turned down.

The business

finance landscape

– an overview

31

%

I didn't

get a bank

loan

1

Meanwhile, the financial services sector as a whole is rife with bureaucratic and lengthy loan application processes. There is also deep-seated mistrust of the banks.

Business finance is notoriously vague over both interest rates and other, often hard to spot, account-related fees, and it can be difficult for businesses to know which lenders offer the best total value, or to understand what additional fees lie beyond the headline rates.

Independent research carried out by Future Thinking

in 2014 for Verus360 showed that 40% of UK SMEs are unaware of not just the effective Annual Percentage Rate (APR) they’re paying for finance, but also of the actual total cost.

To help, we take a look at the typical costs of different types of SME finance, and what hidden costs to look

It can be difficult for businesses to know

which lenders offer the best total value

O F U K S M E S A R E U N A W A R E O F T H E R AT E T H E Y ' R E PAY I N G F O R F I N A N C E

40

%

I'm not

sure how

much I'm

paying for

finance

Why is finance pricing so

complicated for businesses?

Needless to say, business lending is a very different proposition to personal lending. Personal loan providers are obliged, by law, to advertise the Annual Percentage Rate (APR), which takes into account both the interest rate and any fees.

In contrast, business lenders don’t have to adhere to quite the same rigorous Financial Conduct Authority (FCA) legislation as consumer lenders do. The APR of a business loan is rarely advertised, and different lenders will use a variety of methods to calculate their costs. For example, if you search for business loans on

Moneyfacts, two leading banks both state an interest rate of 0.5%, but don’t explain if this is weekly, monthly or annual. They also both state that fees are “negotiable”.

But even when the interest rate is advertised, you can still be hit by a raft of charges in addition to that headline cost – and that’s where you need to be informed and diligent, asking the right questions to understand the

true costs. W E E K O R M O N T H O R Y E A R

0.5

% =

?

The APR

of a business

loan is rarely

a d v e r t i s e d,

and different

lenders will

use a variety

o f m e t h o d s

to calculate

their costs.

Lack of transparency

Our research found that one third of businesses are not confident in the transparency of their current finance provider when it comes to explaining costs.

The challenges facing businesses trying to research finance include:

● Lack of advertised effective APRs

● No comparison sites or search engines that are able

to show typical comparative costs

● Lack of clarity on how different types of finance stack

up in terms of cost

● Attention-grabbing headline interest rates which don’t

include ‘extras’

● Rafts of potential ad hoc fees hidden in the small print

So it’s easy to pay more than you think you will. But it’s not just about the rates – if you have to wait months to get the finance you need, there’s the opportunity cost.

O F B U S I N E S S E S A R E N O T C O N F I D E N T I N T H E T R A N S PA R E N C Y O F T H E I R C U R R E N T P R O V I D E R

⅓

I'm not

confident

that my

current

provider

explains

my costs

clearly

Lead time for loans

According to Smarta Business Builder, a support platform for business owners, the average lead time for a business loan is three to six months.

This is largely due to the huge amount of paperwork needed to successfully apply for a business loan or other type of business finance.

Business finance is still largely stuck in the analogue age. It generally involves face-to-face interviews or lengthy phone calls, application forms, faxes, and reams of other documents which need to be posted, received, checked and signed.

For entrepreneurs running a business, time spent on a loan application – especially an unsuccessful one – could have been better spent generating sales.

And, even after going through this time-consuming process, the loan may not be as big as you need – or you might be turned down completely. Traditional lenders often take a ‘one size fits all’ approach, and don’t always fully understand your company’s commercial and financial profile.

So if you’re looking for finance to expand and grow – or just to manage month-to-month cash flow better – how do you avoid paying more than you should? And which types of finance offer the best total value?

J A N

F E B

M O N T H S

average lead time for a business loan

M A R

There is a bewildering array of finance options for SMEs, and each type

has advantages and disadvantages in terms of pricing and costs.

Our guide can help you understand which option’s right for your business.

Making sense

of your options

2

Traditional lending

● Bank loans 9

● Business credit cards 10

● Bank overdraft 1 1 ● Invoice finance 12 ● Equity finance 14 ● Asset finance 15 ● Short-term loans 17

Alternative finance

Traditional lending

Traditional lenders are still the first port of call for many SMEs. But lengthy application processes and high operating costs can prove a barrier to SMEs looking for simple, low-effort and fairly priced lending.

Bank loans

Bank loans do at least generally offer fixed rates – if you can afford to wait.

PROS You normally get all the money upfront and commit to repaying it, with interest, over a set period. Unlike overdrafts, loans are not repayable on demand, so you’re guaranteed the money for the time you need it – once you’re approved, you can forget about it.

CONS On the downside, it may be hard to keep up

repayments when times are tough, and failure to pay a secured loan can mean you lose assets that secure the loan. You’ll also need to know how much finance you’re going to need for that period upfront – sometimes tricky, unless you’re sure of future sales.

T Y P I C A L

R A T E S Santander quotes fixed rates from 7.9% to 12.9% per _{annum with a £100 arrangement fee. HSBC starts}

from 7.9% annual interest rate with a £100 fee. Other high street banks do not publish typical rates.

Business credit cards

PROS Credit cards are easy to use when you need quick borrowing for purchases, and there's no cost if you repay within the credit period.

CONS Unless you pay off the balance every month, you’ll be hit with a high interest rate compared to other forms of lending. It can be hard to increase your limit, and you’re likely to pay an annual charge just to have the card.

T Y P I C A L

R A T E S Lloyds offers 22.4% APR, with an annual fee of £32 _{per card. Barclaycard comes in at 21.9% APR. HSBC}

charges 15.9% APR with an annual fee of £32, while RBS offers 23.2% APR.

Bank overdraft

PROS Used correctly, and if you stay within your limit, overdrafts tend to be cheaper than a loan – as you only borrow what you need at the time, and you can pay it at any time. They’re also simple to use.

CONS You’ll probably be charged a fee to set up the overdraft. Being permanently overdrawn will be expensive – and the bank can ‘call in’ the overdraft at any time. Plus, you can’t pick and choose overdraft ‘deals’, as you’re tied to your bank account. If you exceed your limit, then expect much higher rates of interest and possible additional ‘penalty’ charges.

T Y P I C A L

R A T E S Rates are typically between 10% and 12% – but if _{you are overdrawn without authorisation, you’ll}

Invoice finance

Invoice financing is where a third party agrees to buy your unpaid invoices for a fee. There are two types of invoice finance: factoring and invoice discounting.

Invoice finance providers will typically offer 85-90% of the value of any approved invoices, but will impose conditions of acceptability – which may mean some of your invoices will not qualify.

F A C T O R I N G

Factoring is where your customers are aware of the involvement of the provider, who will make regular direct contact with them – either as part of the approval process, or to undertake credit control and chase for payment.

I N V O I C E

D I S C O U N T I N G

Invoice discounting is typically confidential, which means you remain responsible for credit control. The provider will typically only contact your customers when problems arise. This service is normally offered to better risk businesses, with a good track record and proven ability to manage their sales ledger.

PROS Both types of invoice finance improve company cash flow in a flexible way, and can be ideal for businesses that either have a poor credit rating, or wish to out-source their sales ledger operation. It requires regular provision of data and can be operationally time-consuming – so if you’re

CONS The paperwork may prove onerous, and running costs are typically high. Invoice finance providers charge service fees for managing your sales ledger, while their agreements typically include a large number of ancillary fees – meaning both the actual cost and the compliance time cost can be high. Many will also have notice periods to exit the agreement, or otherwise charge for earlier exit.

T Y P I C A L

R A T E S Typically, you will pay an interest charge, facility _{fee (% of total turnover) plus admin fees, which can}

significantly increase the total cost.

Factoring: An interest margin of between 2.75%

and 6% over the base rate, and a service fee of 0.5-3% invoice value – irrespective of how much you actually borrow – or a monthly fee of £500 to £1,000. A well established low risk business with turnover of £6.61m and average borrowings of £448,000 paid up to £49,600 per annum or 19% APR. Overall APR % can reach up to 45% on this type of product.

Discounting: Generally, the rates are lower than for

factoring, including charging a flat service fee rather than a percentage of invoice value, ranging from £500 to many thousands, depending on the size of the lend. Typical rates are an interest rate margin of 1.5-4% above base rate, and a service fee of 0.2-2%. A well established low risk business with a turnover of £7.43m and average borrowings of £465,000 paid up to £61,500 per annum or 13.8% APR. Overall APR % can reach up to 25% on this type of product.

Equity finance

Investment or equity finance involves selling part of your business to an investor. Common types of equity finance include business angel investment and venture capital.

PROS There’s no loan to repay and you may benefit from the skills and experience of your investors to help grow your business.

CONS You’re selling part of your business and need to be sure that the short-term gain of the cash injection makes the loss of equity, or ‘dilution’, worthwhile.

T Y P I C A L

R A T E S There’s no interest rate for equity finance. _{Businesses selling a share of the company for cash}

will negotiate with the investor how big a share they will sell for a sum of money – think Dragons’

Den. Ultimately, you are giving away a share of the business – and of future profits.

Asset finance

Asset finance is used to break down the cost of buying equipment into smaller payments. For example, a printing firm may buy machinery in this way. Asset finance is usually done via leasing or hire purchase, and it releases capital against currently encumbered assets.

b

Lenders will look at the following criteria when assessing pricing:

● Asset type ● Asset age ● Sector

● Credit quality ● Supply route

They will also look at any additional security, such as:

● personal guarantees ● supplier warranties ● company’s track record

PROS Some businesses can arrange a lease and/or lease back arrangement on equipment used by the company for business purposes, such as running vehicles, etc. This reduces the pressure of raising up front capital for purchases, and is useful as it allows the business to spread the costs across a pre-determined timescale.

CONS You usually won’t own the asset itself following the end of the arrangement (unless you pay extra for an ‘option to purchase’ within the agreement), and asset finance can be more expensive than buying the asset outright over the term of the arrangement. You can’t claim capital allowances on a leased asset if the lease period is less than five years.

T Y P I C A L

R A T E S Most lenders base their pricing on a risk versus _{reward model, and/or the size of the transaction.}

For example, the cost of a £45k, 60-month asset finance agreement for an A1 credit manufacturing company with a net worth of £1m would be charged at an interest rate of 9% plus fees of £275.

In contrast, the cost of a £75k, three-year agreement for a start-up leisure facility with no financials, weak assets and personal guarantor driven security,

Short-term loans

As well as high street names, there are numerous short-term lenders and finance providers. These tend to show loan costs in different ways.

PROS Access to this type of finance may be faster than via the banks, and you may be able to apply partly online.

CONS Prices are typically much higher than other forms of business finance – although this isn’t always apparent in the ‘headline’ rates. Check the APR, if this is available, to see the true total cost – which may be significant.

T Y P I C A L

R A T E S These vary hugely, but you’re looking at more than _{most traditional lenders. Many lenders don’t quote}

an interest rate, but APRs well above 500% are not uncommon. Both Ezbob and Everline charge £2,600 interest on a £20,000 loan over 12 months. Iwoca would charge £2,800 interest on a six-month £20,000 loan.

Alternative finance

Alternative finance can be cheaper and more easily accessible than traditional lenders – largely due to lower operating costs, given that many of the providers embrace digital technology. It can also mean faster funding and more transparent costs.

Peer-to-peer loans

PROS Peer-to-peer loans are a cheaper and faster alternative to bank loans. There’s no bank – instead, borrowers are matched with ‘lenders’ via internet platforms.

CONS Businesses will need to meet certain criteria such as having a proven track record – so it’s not necessarily appropriate for start-ups. You may also be charged a ‘completion fee’ by the platform based on the amount you’re borrowing, in addition to the interest you’ll pay.

T Y P I C A L

Crowdfunding

Crowdfunding describes a large number of people investing, lending or contributing smaller amounts of money to your business or idea.

PROS Crowdfunding can be a faster alternative to traditional lenders, and you might find more support here than via the banks if your business is a start-up.

CONS You may need to return the money to investors if you don’t reach your stated target. You’ll need a compelling business idea, and plan, to attract investment.

T Y P I C A L

R A T E S There are no interest rates as such as you are either _{selling a share of your business or offering rewards.}

If you sell equity you’ll have to share your business’s success with investors.

Invoice trading

Invoice exchange platforms allow investors to bid for your invoices.

PROS In some cases, you can apply and have funds in your account within a week or two – and it’s flexible in that you can choose which invoices to sell.

CONS You need to apply each time you want extra working capital, so it can be time-consuming if you need finance on a regular basis. It’s not particularly cost effective, and you run the risk of nobody bidding for your invoice.

T Y P I C A L

R A T E S Market Invoice quotes a typical cost of 3.8% to 4.1% _{of the face value of the invoice, based on an invoice}

of £12,500 and an annual turnover of £100,000 – although this varies by invoice value and quantity. Platform Black charges interest (discount), plus a fee of 1% of invoice value.

So what are the hidden costs you need to look out for, and how

do you spot them?

Here's our handy guide to some of the most common pricing pitfalls.

t

Arrangement or set-up fees

Arrangement fees (also known as set-up or commitment fees) are commonly charged for different types of business finance.

There are two types: non-refundable and refundable (once you are a customer).

HOW MUCH WILL IT COST?

These can range between £500 and £10,000, but some lenders charge a percentage of the amount borrowed. One leading bank, for example, charges up to 1.5% of the loan amount, while Everline charges 2%-7%.

Identifying the

hidden costs

t

_{Fees for everyday services}

Many business lenders charge you for everyday administrative services and lenders tend to add a (sometimes significant) margin on to fees from third parties such as banks. These ‘invisible costs’ can include making a transfer, creating a report, extra documentation, personal visits, extending your funding limit – and much more. They can be calculated in different ways (a percentage on the excess or facility limit, or fixed). The risk profile of your business may also affect what you're charged.

HOW MUCH WILL IT COST?

One major high street bank, for example, charges an account maintenance fee of £5.50 a month, 19p per credit, 23p per bill payment made online or by phone, £5 per bill made in branch, and 80p plus 0.6% of the amount per branch credit.

The factoring and invoice discounting industry has a wide and varied tariff mechanism which allows those lenders to charge additional fees for any and all potential eventualities – thus making the overall facility more costly than would have been originally negotiated. Fees could include the following: Payment transfer fee (£15-30 per transmission), payment extensions (0.5% to 4% charged against the additional value required above agreed fundable limit), annual review fees, charged either on a fix value basis (eg. upwards of £500) or a percentage against the additional uplift (ranging from 0.5% to 2%), plus various charges for

t

_{Penalty fees (missed payments etc)}

If you stray outside of your agreed overdraft limit, even for a very short time, the total amount you pay for your finance could balloon past the costs you see upfront (your core borrowing).

Penalties are commonly charged for unauthorised borrowing.

HOW MUCH WILL IT COST?

These can be significant and are often hidden – sometimes lenders will just include a generic clause which doesn’t explain rates or charges.

t

_{Non-utilisation fees (or monthly or annual ‘minimum fee’)}

Some lenders – often those offering factoring or invoice discounting – will charge you for access to finance, even if you don’t use it, to keep the account open.

HOW MUCH WILL IT COST?

The amount charged depends often on your turnover. For typical SMEs, fees generally start at between £6,000 and £10,000 a year, although they can run to tens of thousands, equivalent to APRs of 10-20% of the facility limit.

t

_{Contract/facility review fees}

Annual facility reviews are often chargeable, generally within the invoice finance industry.

If you’re a growing business, or one with seasonal peaks and troughs, check if the lender charges for these reviews and work out how much this will cost you over the first year to see if the cost is justified.

HOW MUCH WILL IT COST?

This is usually an annual event to check your risk profile, and you’ll be charged around £500 to pay for the audit (and a visit if necessary) – but the amount will vary according to the complexity of your company accounts.

t

_{Exit fees}

It might seem unfair, but some lenders will charge you for closing your account, even if you’re fully paid up – especially if you leave before your contract end date.

HOW MUCH WILL IT COST?

It depends on how far into your contract you are, if this is fixed term, but as a guide it could be up to 15% of your facility limit.

Covering off the basics

Research carried out in 2014 for Verus360 found that

more than 50% of SMEs don’t complete consistent due diligence when it comes to researching finance

and finance providers.

This may sound obvious, but be sure to read the small print carefully. You’d be surprised at just how many people don’t.

Always ask the lender for a full list of both their standard and ad-hoc tariffs.

Make sure you know your rights, which you can find out from the appropriate regulatory or industry body (which could be the FCA or The Asset Based Finance Association, depending on the lender).

Finally, if you are charged, and you don't think it’s fair,

challenge the fee. Most lenders have a complaints

process, and many can waive or reduce charges if they are deemed to be unjustified.

It’s a confusing landscape, so weigh up your options carefully – and make sure you know what you’re committing to!

I didn't

read the

small print

50

%

Introducing

Verus360

4

Versus360 is a new type of business finance, available online,

offering SMEs a unique combination of benefits.

We work in a different way to traditional lenders. We use our tried and tested technology to securely analyse your financial data, and combine this with independent commercial data to make fair and commercially objective decisions.

You decide how much finance you want to use (up to the agreed amount) and when you want it. You only pay for the money you use and only for the time you use it. You’ll pay one simple rate, there’s no minimum fee and no zero notice period.

By looking into your business finances, we can also help you make more informed decisions and potentially save money.

`

One simple,

transparent fee

`

_{No hidden}

charges

`

Online account

management

`

_{Zero notice}

period

`

Pay as you use

`

_{24/7 account}

Get in touch

Verus360 Limited, 1 Eversholt Street, London NW1 2DN Registered in England and Wales (co. no. 08812878).

Registered office: 105 Duke Street, Liverpool, L1 5JQ, United Kingdom.

     info@verus360.com (0) 20 7554 0700 www.verus360.com @Verus360 linkedin.com/company/verus360

Verus360 is a UK-based business dedicated to delivering innovative online business finance products and services to small-to-medium-sized businesses (SMEs).