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No home, no loan: what the housing crisis means for SMEs

Banks often insist start-up business owners provide their home as security if they want finance. But the housing crisis means fewer entrepreneurs, particularly younger ones, can afford a house.

In the second of a series on small business brought to you in association with Callaghan Innovation, Nikki Mandow looks at what this means for SMEs - and New Zealand.

When small business owner Scotty Baragwanath needed $300,000 to fund his start-up cereal business, he realised pretty quickly he wasn’t going to get money from the bank.

It wasn’t that he didn’t have business experience or an understanding of what customers want to eat. After 20 years with confectionery giant Mars, Baragwanath knew plenty about food products and consumers.

He reckoned his flavoured porridge and gluten-free cereal brands would work well both in New Zealand and overseas.

What Baragwanath didn’t have was his own home. He and his wife used to have a house in Australia, but they sold it in 2015 to get capital to start their business, Blue Frog.

Since then the couple and their four young children have rented in Auckland.

Which meant, in the bank’s eyes, they didn’t have any security for a business loan.

Which meant no bank was going to give them money. Period.

After a couple of chats with bank managers, where the sum total of their offering was an extra $2500 on his credit card limit, Baragwanath went elsewhere, raising the funds he needed from private investors.

Blue Frog has just started exporting its cereals to Australia and has plans to be selling in the US via Amazon by the end of the year. Photo: Supplied

These original funders are still supporting Blue Frog, and he’s gained expertise as well as finances, he says.

But it’s also meant months courting potential investors. And Baragwanath has had to significantly dilute his stake in his own business. He lost 30 percent in the first tranche of funding, and has given up more since.

“It would certainly have been easier if we could have got money from the bank. But they have not wanted to walk with us.

“Even after the first year, when we had turnover of around $250,000, and we had won our first food award and were getting amazing feedback from customers, our bank told us we weren’t attractive. They said we should come back when we were at a stage where we were making money."

Same story in 2017, with Blue Frog at that stage turning over more than $500,000, with four staff.

“Even then they would only consider lending if we had a personal guarantee. I had no assets and why would one of our backers provide a personal guarantee?”

Blue Frog needed several hundred thousand dollars.

“They gave us an extra $10,000 on our overdraft - but even then we had to guarantee it.”

“It would certainly have been easier if we could have got money from the bank. But they have not wanted to walk with us."

- Scotty Baragwanath, Blue Frog

Baragwanath isn’t dissing the banks. He’s just telling it as it is. Banks mostly won’t lend to businesses unless they have some guarantee they’ll get their money back. And that security is often the business owner’s family home.

The problem is that with house prices soaring, fewer people - particularly younger people - are able to afford a home. The most recent Statistics NZ figures - from the 2013 census  show the number of 30-39 year olds with their own home fell from 55 percent to 43 percent between 2001 and 2013. For people in their 40s, the numbers were 71 percent in 2001 and 61 percent in 2013. 2018 census data won’t be released until March next year, but there’s no doubt home ownership will have fallen further.

Andy Hamilton heads The Icehouse, an Auckland-based not-for-profit working with SMEs to help them grow. He says getting money from a bank is already hard, and it’s getting harder.

Worse, the funding gap isn't just about owners unable to borrow to start or grow a business, but about SMEs not being able to get short-term finance to see them over a temporary cashflow bump. And that’s of real concern because so many SMEs have trouble with cashflow. Xero’s Small Business Insights data for June this year, shows less than half of New Zealand small businesses (or the ones using Xero accounting software anyway) had positive cash flow. And the banks often can’t or won’t help.

“There’s too much friction in the lending process. It takes too long and it’s too hard,” Hamilton says. A bank loan (even if one is available) can take up to six weeks to process and require as much paperwork for a small business as a large one.

Add the housing crisis into the mix and “people are coming to the realisation that we have to prepare for a world where there’s no collateral for small businesses”, Hamilton says.

Banks aren’t the only option for SMEs; there are so-called “third party” lenders, like Harmoney, Nectar, or Fuelled. Overseas there are more creative products, Hamilton says, that might emerge in New Zealand.

For example, US banking/lending startup Oxygen offers financing to contractors based on their own digital financial data, including income and expenses. But it doesn’t just wait to be asked - it offers funds to fill a possible gap before it happens. This same idea could easily be applied to SME businesses, Hamilton says.

US-based banking app Oxygen aims to offer finance before you even know you need it. Which might be good for busy, cash-strapped small business owners.

Xero’s small business director Nicole Buisson also believes the present model - where companies ask their bank for a loan, often having to go into an office and fill in a load of paper forms, and provide security - is crazy. She says the technology is there to allow banks to make far better lending decisions, far more quickly.

Third party lenders like MarketInvoice in the UK and Waddle in Australia already provide unsecured business loans based on a company’s financial information, taken digitally from their own online books. In New Zealand, German-based Spotcap considers unsecured loans of up to $250,000 for SMEs turning over at least $200,000 a year and able to supply two years of financial information.

“They are doing clever things using data from the Xero platform, all digitally, to decide if they should lend to a company,” Buisson says.

Data includes information about outstanding invoices, as well as financial performance.

But the alternative finance market is still tiny. Buisson estimates as much of 90 percent of SME lending is still through banks.

“The majority of the activity is coming out of the UK, but it’s just a matter of time before we see it coming here too,” Buisson says. “Certainly I’d like to see more [alternative lending] and the Xero system can enable that.”

The University of Auckland's Dr Benjamin Fath says the government must look at guaranteeing loans for SMEs. Photo: Nikki Mandow

The University of Auckland’s Dr Benjamin Fath studies growth and innovation in New Zealand SMEs, and reckons the government should think about getting involved with SME finance. Fath says the problem isn’t just that fewer and fewer people can afford a house, it’s just the present loan system doesn’t work at all.

Fath says his research suggests most SME business owners decide not to use their home as security for a business loan because that’s just too risky for their family. Instead, they choose a slower, safer path - funding growth through cashflow. This has a huge impact on SME productivity and potentially New Zealand’s GDP.

“The government talks about SME productivity, but the issue of underinvestment in small firms has not been addressed.”

Benjamin Fath, University of Auckland

“[Not being able to borrow] leads to underinvestment, or to people making investment decisions that could be counter-intuitive. For example, you might have the option of buying a $2 million machine from overseas, with your house as collateral, or hiring three more people just above minimum wage.”

The machine will improve the company’s productivity, and business performance, but the owner chooses not to risk her house. Instead she takes on more staff at just above minimum wage, funded by cashflow, knowing she can lay them off if it doesn’t work out. It’s not the best option for the business, but it doesn’t put the family home on the line.

“The government talks about SME productivity, but the issue of underinvestment in small firms has not been addressed,” Fath says.

Overseas, many governments have introduced credit guarantees for SME businesses, involving government backing small business loans, he says. Success has been mixed, but he says our government should at least be looking at the idea.

“If I had a wish for Christmas, it would be discussion about government loan guarantee schemes. Even the World Bank, which isn’t a big fan of government involvement, have recently published a policy document about how to implement these type of things. They think it’s a great idea.”

Read more: Asia racing ahead of us in small business

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