Fiddich Review Centre
Alternative Investment

Small-cap funding drought may lead to alternative lending groundswell

Small businesses are facing a lending crisis of two halves at the moment.

On the equity front, the amount raised by existing companies on the London Stock Exchange’s junior AIM market declined by more than two-thirds to £2.23bn in 2022, according to data supplied by AIM Journal.

Furthermore, “there do not appear to be many new companies planning to join AIM in the short-term and there are more leavers likely in the coming months,” said the journal’s editor Andrew Hore.

Volatile market conditions have also brought a definitive end to cheap money on the debt front.

According to the Federation of Small Businesses, a survey of members found that successful applications for bank loans and other financing fell significantly in the latter half of 2022, with less than half of applications getting approved.

The FSB warned that lenders could completely withdraw from the market, in a grim parallel to the post-2008 credit crunch.

As Liberum’s equities analyst Joachim Klement put it: “A bank is like someone willing to lend you an umbrella just to ask for it back when it starts to rain.”

“The major problem for smaller businesses,” Klement told Proactive, “is that banks are worried about both rising interest rates which may reduce the ability of companies to service their loans, and the looming recession. As a result, banks have started to tighten their lending standards.”

“A bank is like someone willing to lend you an umbrella just to ask for it back when it starts to rain”

Retail and consumer goods companies seem to be getting the worst bargain out of this funding drought, with Klement observing a reflection of the ongoing cost-of-living crisis and the fact that, especially in retail, there have been quite a few companies going into administration. 

“Banks are very reluctant to lend in this sector for fears their borrower may be the next one to fall,” he said.

However, small caps aren’t alone in finding reasonably priced funding, with mid caps and large caps also struggling to secure deals.

Klement noted: “Unless the company’s balance sheet is solid and earnings visibility is high, loans will either be very expensive or not available at all.”

Given the evaporating supply of money from traditional routes, it would make sense for companies to start seeking out alternative lending capital-raising streams, which is exactly what Superdry did when it secured a £30mln facility with US-based lender Bantry Bay Capital Limited (LSE:CAPD) last month.

Just this week, British self-driving software start-up Oxbotica has successfully raised US$140mln (£115mln) in a series C funding round comprising investments from some notable venture capital funds, including Japanese insurer Aioi Nissay Dowa Insurance, Japanese oil refiner Eneos’ VC arm, and Chinese giant Tencent.

Read more: Oxbotica successfully raises £115mln in a boost to Britain’s self-driving sector

The potential for a secured lending groundswell in the coming months and years could prove a novel investment play into small- and micro-cap alternative investment funds, especially since Klements noted that “we think financing conditions are unlikely to change soon. We expect the Bank of England, Fed and European Central Bank to not cut interest rates this year, and for the recession to last until the end of 2023”.

“In short, 2023 will be a year of recession uncertainty and high financing costs. So no relief this year, he predicted.

But if 2023 really is the year of alternative lending, it could result in further pain for the junior stock market as businesses seek to shore up capital from the secured debt market instead.

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