Why revenue-based financing for SMEs is key to fighting the energy crisis

The forecasts are in. Businesses are going to have a hard winter. But revenue-based financing for SMEs provides a sigh of relief for small businesses who are looking to counter rising operational costs.

We’ve written before about how rising inflation will impact small businesses, but the looming energy crisis poses another specific challenge. The Federation of Small Businesses estimates that between February 2021 and August 2022, electricity and gas bills have risen 349% and 424% respectively, and we’ve already seen the effects.

Over the last two years, 87% of small business owners reported losing an average of £20,981 to the pandemic and other factors. By the second quarter of 2022, they were already facing still higher costs, and the situation is set to worsen. The coming quarter has many business owners concerned. The numbers speak for themselves:

• 64% of SMEs say they are worried about the forthcoming increase in the energy price cap, including 30% who are “very worried”
• Around 53% of SMEs expect to stagnate, downsize, or fold in the next year.
• Nearly 14% of SMEs expect to close their businesses in the coming 12 months.
  

Households and businesses of all sizes are going to take a hit by the ongoing crisis, but SMEs are particularly vulnerable. Without the capital reserves available to larger enterprises, small businesses can struggle even with relatively predictable fluctuations in cashflow. Hospitality and leisure businesses naturally see their revenues change with the seasons, but an unprecedented increase in energy costs is likely to hurt the entire SME ecosystem. 

Some companies are seeing their energy bills go up 600%. It’s no wonder that 11.5% of companies made credit applications between April and July this year (up from 9.1% in the previous quarter). It’s been historically difficult for SMEs to access credit from traditional lenders. With these new challenges, the obstacles will only become greater.

Traditional lending options aren’t enough for today’s challenges

All SMEs are likely to be affected by the energy crisis, but let’s consider one potential scenario. 

Sara started her boutique ice cream company just before the pandemic, and despite Covid-19, business has been good. She made the most of a lockdown-free summer and set up a cart catering to customers on their daily walks. She supplies to retailers as well, and her high-end product even keeps a steady flow of customers in the winter. In fact, the first quarter of 2022 was her best yet. 

With the rising cost of energy, though, she’s one of many business owners who are worried. She has limited working capital to pay staff and bills at the best of times, and it takes a lot of energy to produce, refrigerate, and distribute her ice cream. With the cost of overheads rising, she needs credit to keep going until the economy stabilizes. But her opportunities with traditional lenders are limited:

• Traditional lenders are not fast enough. Small businesses like Sara’s can’t predict ahead when cash will be so low that it will be worth taking a loan, but when it does get to that point, they need the funds almost immediately. Traditional lenders are often ill-equipped to meet that need.
• Applications are too complex. Most traditional platforms employ complicated systems and require various physical documents, leading to 57% of all SME credit applications being abandoned because they’re too difficult to complete.
• Simplistic risk assessment locks out many SMEs from obtaining financing. A traditional lending platform will rely solely on revenue and operating history for approving credit, both of which a successful but young SME like Sara’s is unlikely to have records for.
• High interest rates and repayments mean that many SMEs don’t even try to apply for credit. For a business like Sara’s where revenue is likely to fluctuate seasonally anyway, and net profits are especially subject to energy costs, a fixed interest rate is a huge deterrent to borrowing.
  

As the energy crisis begins to bite all kinds of companies, compounding already pressing challenges like inflation, seasonality, and the aftermath of the pandemic, traditional funding solutions need an upgrade more urgently than ever.

How revenue-based financing for SMEs an solve the cash flow problem created by the energy crisis 

The energy crisis may be with us for some time, and a business like Sara’s is likely to struggle, but with ready access to funding she can invest in more energy-efficient equipment, maintain working capital, and set up partnerships with more seasonally immune retailers like supermarkets. Revenue-based financing for SMEs helps platforms overcome the challenges of lending to their business customers, and helps businesses like Sara’s access the credit they need to weather the coming storm.

• Speed isn’t a problem with embedded finance. A product like YouLend’s allows platforms to release funding in minutes rather than weeks, easing SMEs’ concerns.
• Complexity doesn’t need to be a worry either. Fully integrated embedded finance solutions make credit applications a short, seamless experience, and white-label products enable platforms to create a seamless customer journey from application to approval.
• Reliance on traditional credit checks is no longer an obstacle to approving funding. Because revenue-based financing for SMEs operates under a different regulatory regime than traditional lending, platforms can consider a whole range of credit markers, allowing Sara to prove her business’s viability with online customer reviews, social media activity, and other metrics.
• High interest rates don’t need to be a concern for SMEs with fluctuating revenue. Revenue-based embedded finance allows borrowers to repay a percentage of their revenue instead of a fixed rate, giving them the confidence to apply for the credit they need even when energy costs and other variables are uncertain.
  

Final thoughts

Although the new government has indicated plans to ease the effects of the energy crisis, it’s still uncertain what provisions will be made to help small businesses. The revenue-based financing solution is of particular importance to enterprises working with SMEs because with this offering, they are able to keep many promising businesses operational through the cost-of-living crisis and nurture long-term merchant retention for their platform. 

The crisis is likely to be with us for some time, but with accessible funding, many SMEs can receive the support they need to get through it.