Financing investments what alternatives do SMEs have
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Financing investments: what alternatives do SMEs have?

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How can small and medium-sized businesses prepare for future investment financing? Simply resorting to the classic bank loan will no longer be sufficient. Rather, SMEs need to diversify their financing. Alternative financial instruments can help.

How do I finance the next investment? This is a question that worries many managers in small and medium-sized enterprises (SMEs). Small companies in particular are left out when it comes to lending by banks. According to the latest company survey by the federally owned Kreditanstalt für Wiederaufbau (KfW), 19.4 percent of small businesses (up to EUR 1 million in sales) have difficulties accessing credit. Small companies are two to three times more likely to encounter problems in obtaining outside capital than companies with sales of more than 1 million euros.

Nevertheless, small and medium-sized companies also have to invest – and a flexible financing strategy is essential for this.

High hurdles for bank lending

In order to secure the financing of investments, SMEs have to combine traditional and alternative financial instruments. Because access to outside capital will become more difficult for medium-sized companies in the coming years. The persistent phase of low interest rates and a strict regulatory framework make it much more difficult for banks to grant loans to SMEs. In addition, there are increased financing costs on the part of the banks due to fees and commissions.

Small and medium-sized companies are increasingly deterred. Above all, there are bureaucratic hurdles that can hardly be overcome. Many companies want faster credit decisions and fewer mountains of paper. So if you need additional financial leeway quickly, the digital route is more suitable. In addition, small and medium- sized businesses have discovered alternatives such as crowd investing, crowdlending or sale & lease back.

 

When it comes to financing issues, many SMEs first go to the house bank, but companies are increasingly using digital alternatives to raise capital. The aim for small and medium-sized companies must therefore be to ensure the broadest possible and balanced corporate financing with a mix of different instruments and donors.

Financing investments through a mix of financial instruments

Why is this development necessary? As a result of the Basel III reform package, SME financing will change in the years to come. The package provides for high equity ratios that banks will have to demand from companies in the future. SMEs therefore need financing models with which they remain flexible and adaptable.

There are also other factors that make small and medium-sized businesses need to diversify their funding. According to the study “Industrial SMEs and Financing 4.0” , the globalization of the economy, international trade conflicts, demographic change and an increasing shortage of skilled workers are the greatest challenges for German SMEs.

These uncertainties have a negative impact on the financing of investment projects. This mainly affects companies that are under constant pressure to innovate and invest. Borrowing is more difficult for them. Easier and faster access to capital is therefore crucial for many medium-sized companies.

 

Do not replace bank loans, but supplement them

These types of access offer alternative financing models. Medium-sized and small companies use them to finance investments or to create new production capacities. You thus expand the range of financing instruments and make yourself less dependent on traditional bank loans.

However, this does not mean that SMEs will in future completely forego bank loans. Rather, the various financing options should be combined with one another in order to achieve the highest possible degree of flexibility. Banks are also increasingly offering alternative financing models apart from their core business. This allows companies to quickly adapt to new circumstances. For example, they can collect capital more quickly or combine the raising of capital with marketing measures to increase their awareness .

Improve equity ratio

Alternative forms of financing such as crowd investing also have the advantage that companies receive mezzanine capital. In the company balance sheet it is treated as economic or balance sheet equity. The self-financing of investments with funds from alternative capital procurement can also be a sensible way to improve the equity ratio. The equity ratio is the share of equity in the total capital of a company. This makes it easier for companies to get a bank loan.

 

Small companies and start-ups in particular benefit from this. According to a study by the Bonn Institute for SME Research, such companies are particularly affected by funding restrictions. “Company size” and “innovative strength” are the main exclusion criteria for lending.

Rely on self-financing

But in order to survive in competition, the business models of small businesses and start-ups in particular have to constantly develop. Most recently, this has primarily meant investments in digitization projects. According to a recent survey by Star Finanz, almost 77% of SMEs are intensely dealing with digital change. At the same time, they are demanding more digital services from their financial institution – beyond what is currently available. However, banks find it difficult to grant loans for such projects because there is hardly any collateral available. Digital capital procurement is also better suited for these investment projects.

Regulatory conditions, market risks and reluctant banks: The financing of investments will become more demanding for small and medium-sized companies in the coming years. In order to remain competitive, SMEs should therefore not only rely on traditional bank loans, but should also expand their range of financing to include alternative instruments for raising capital.

Peter High
I've written for the Wall Street Journal, CIO Magazine, CIO Insight, Information Week and several other periodicals. I am also the author of Implementing World Class IT Strategy: How IT Can Drive Organizational Innovation.

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