For most of the twentieth century, business lending was based on the value of a company’s assets such as property, stock or invoices. To help firms access funding, accountants have therefore developed a good understanding of how lenders would assess a company’s physical assets.
However, business has changed. Today, companies are more likely to be investing in intangible assets such as data, software or a strong brand, than tangible ones.
The investment in intangible assets has spurred growth and innovation. But using them as collateral to borrow against remains difficult as, although value is built in intangible assets, finance is raised against tangible ones. Furthermore, it is estimated that tangible assets continue to decline as a percentage of total assets in the UK.
So, without a new approach to funding, accountants can struggle to find suitable finance for their small but growing clients in asset-light sectors such as professional services, technology or media.
What’s the problem?
Companies now build and grow through investment in intangible assets and a continued focus on human capital. We can see this from the businesses that succeed today.
Airbnb is valued at $35bn because of its network and data, not because it owns apartments. Google has become a global behemoth because of its algorithms. Uber owns no taxis. These companies are valued so highly because of their intangible assets, including the skills of the people that develop them.
The same is true of many small but growing businesses here in the UK. Service-based businesses contribute around 80% of UK GDP and more than £160bn in annual exports.
Growing media businesses, financial firms, and even gyms rely on intellectual property and brand to stand out from their competitors. But because financial standards have not kept pace with these changes, we struggle to accurately value these businesses and their assets.
The impact on lending
Intangible assets present a challenge to traditional lending models based around recoverable security such as property or machinery. If a company with physical assets goes out of business, a bank can recover its money by selling those assets. Lending decisions can therefore be centred around the value of the assets, rather than the performance of the business.
Intangible assets are less transferable, they cannot easily be recovered and sold to a new owner. As a result, businesses with intangible asset bases find it more difficult to access debt finance, regardless of the strength of its operations and the associated cash flows.
Marc Fecher, managing director of media and technology experts Kingston Smith Corporate Finance, explained: “Intangible assets are difficult to value because they don’t generate cashflow and aren’t readily saleable, which presents challenges for raising finance from traditional sources.”
When we consider that the asset-light service sector is such a vital part of the UK economy, this creates brakes on economic and productivity growth.
So, what’s the solution?
Traditionalists will say equity funding through venture capital or private equity is the solution. Often that holds true.
However, third party investment does not suit every sector, business or owner manager. It also dilutes ownership which is not a good outcome for family-owned companies.
Instead, asset-light companies can now benefit from unsecured lending, based on an understanding of the future cash flows generated by the business; rather than the value of a particular hard asset.
Where do accountants fit in?
Accountants play a central role in helping these businesses access the right funding. Both by identifying suitable lenders and in developing the forecasts and business plans central to a credit process based on future cash flows.
Fecher said: “In a competitive marketplace, equally important for funding are factors such as the value proposition and the quality of financial information, both of which are common traits of businesses that have high quality strategic advisors.”
Borrowers should beware that not all unsecured lending is indeed unsecured, with some lenders asking for a floating charge over all the assets of the business, or a personal guarantee from the management.
Accountants can help their clients navigate these challenges and secure the best funding outcome. When small but growing businesses are so important for growth across the economy, we need to all we can to help fund them. We need a new approach to lending where accountants support their SME clients to access the finance they need to grow.