Non-Bank Financing Options for Australian Businesses
Updated: Mar 1
For many businesses, raising much-needed capital to fund further growth and expansion is crucial to their long-term success. Traditionally, that means, securing it from banks. However, strict regulations and complicated paperwork to get bank loans often discourage small businesses and startups from seeking bank funding that's why many have opted to reach out to non-bank lenders that offer more flexible alternatives.
The Non-Bank Lending Landscape
The growth of non-bank institutions in Australia is fueled by the need to increase competition in a highly concentrated banking sector dominated by the “Big Four” - ANZ, CBA, NAB, and Westpac. This bank oligopoly provides 80% of all corporate funding as compared with 54% in Europe and 16% in the United States. There has always been a demand to open up the lending landscape to new players that offer competitive and flexible alternatives to traditional funding sources that is why new regulatory policies have been proposed giving rise to this emerging financial sector.
In a few years since the Great Recession, Australia has emerged as the second-largest market to non-bank and alternative lenders next to China. These new players have a very significant role to the economy as they fill a vital market gap by helping the often-underserved segment of small businesses, startups, and mid-level enterprises. Unlike traditional banks, they offer new ways of doing business by providing opportunities to many Australian businesses with a variety of innovative, flexible, and responsive solutions that they don’t get even on high-street banks. Although the market is still dominated by the major banking institutions, specialist lenders have a more client-centric approach that make them an ideal partner to work with as they provide quick, flexible solutions that are well-suited to specific business needs.
a. Key Players in Non-Bank Sector
There are many non-bank lenders in Australia right now and many new players have emerged with some offering competitive rates. Over 600 of these players make up 7% of all debt financing in the country. The major ASX-listed players include Plenti Group, Harmoney, FSA Group, Money 3, Prospa, Wisr, MoneyMe, Resimac, and Pepper Money.
b. Regulation of Non-Bank Lenders
Most people agree that traditional banking is safe as it is subject to greater government scrutiny and regulation. Contrary to most public assumptions, non-bank lenders also have to comply with intensive legal and industry codes like the Australian Securities and Investment Commission (ASIC), the Australian Consumer Law, the National Consumer Credit Protection, the ePayments Code, and the Privacy Law. More importantly, another layer of regulation administered by the Australian Prudential Regulatory Authority (APRA) applies to non-bank lenders.
c. Effect on the SME Market
The SME market saw rapid influx of capital and investment along with expectations of increased debt structures and credit options. However, most non-bank lenders don’t have the resources and budget comparable to the big banks. That means, most mid-sized company CFOs have less resources to navigate the rapidly growing financing opportunities.
Many borrowers are forced to do their due diligence and seek private credit through tedious RFP processes with little information on how non-bank lenders utilise their capital. More importantly, the search process can be overwhelming as some of the non-bank lending options are backed by insurance companies, family offices, and fixed income funds.
By Definition: What is a Non-Bank Lender?
In simple terms, a non-bank lender is not a bank or credit union, but it has its own source of wholesale funds and lends it out with an added margin for profit. The main difference between a bank and a non-bank financial institution is that non-banks cannot accept deposits from the public. They can be a mortgage manager, who borrows from a bank at wholesale rates and lends it out with a margin added.
a. How It Works
Since they are not licensed and regulated as traditional banks, they mainly engage in financial activity when over 85% of their consolidated annual gross revenues or assets are financial in nature. They also offer services such as loan and credit facilities, currency exchange, retirement planning, money markets, underwriting, and merger activities.
Many non-banking financial institutions operate as investment banks, mortgage lenders, money market funds, insurance companies, hedge funds, private equity funds, and P2P lenders.
b. Common Lenders
There are three common types of non-bank lenders:
mezzanine funds, and
venture debt lenders.
Asset-based lenders work well with businesses looking for working capital and liquidity for fixed assets. Loans are usually provided for machinery and equipment, accounts receivable, inventory, purchase order, real estate, and intellectual property. Borrowers can expect to get loans from $2 million to over $100 million while equity sweetener is rare.
Mezzanine funds are perfect for businesses looking for growth capital, business expansion funding, and refinancing. Typical collaterals include second lien tangible and intangible assets. Borrowers can expect to get loans from $5 million to over $100 million while extra sweetener is required. Covenants include cash flow leverage and debt service coverage.
Venture debt lenders are best suited for tech companies looking for growth capital and business expansion funding. Typical collateral include all asset lien, A/R, intellectual property, and other fixed assets. Borrowers can expect to get loans from $1 million to $50 million while equity sweetener is frequently required. Covenants include minimum revenue, EBITDA liquidity, and fully covenant lite.
The APRA is the main institution that exercises regulatory powers over non-bank lenders. It is also required to consider efficiency, competition, contestability, and competitive neutrality. It oversees:
the overall size of the non-bank lending sector with particular focus on the market shares of the higher-risk lending segments.
the lending practices of non-bank lenders and determine if they contribute to downward pressure on industry standards.
the potential spillover effects given the possible reduction of higher-risk lending regulated entities that could spread to non-bank lenders.
the insights from other regulators, like the ASIC.
Non-banking financial institutions can be categorized as risk pooling and contractual savings. Risk pooling institutions include insurance companies while contractual savings institutions include collective investment vehicles and mutual funds. Then there are broker-dealer institutions that quote a buy and sell price for assets (equities, government and corporate debt, derivatives, and foreign currencies) held in inventory. Specialised sectoral financiers provide a limited range of financial services to a targeted sector.
Why Non-Bank Lending
When it comes to choosing the best financing option for small- to medium-sized enterprises, business owners, entrepreneurs, and startup founders have to consider the pros and cons of either bank and non-bank lending is suited to their short-term business needs and long-term expansion goals.
a. More Expedited Processes
Since non-bank lenders are smaller organisations with less bureaucracy, there are fewer regulatory burdens to overcome when it comes to approving loans so that business owners will have clarity and certainty that their timetables will be met as they receive their much-needed funding. With just basic business information and financial data, business loan applications will be completed in an hour.
b. Long-Term Flexibility
Thanks to fewer regulatory requirements, non-bank lenders have the ability to create tailor-made loan agreements that include longer interest-only periods, customised amortisation schedules, and more varied covenants. They can reduce cash payments in exchange for higher interest rates. Moreover, they can also adjust the amortisation schedule and maturity to go along with the expected performance of the business.
c. Assist Growth Opportunities
Non-bank lenders tend to execute an equity sweetener alongside the debt transaction. Although most businesses would oppose any equity participation as debt reduces the dilution associated with a capital raise. However, equity participation often aligns the lender’s economic interests with the business owner’s long-term growth interests. With mutual interest in mind, the lender is willing to relax covenants, reduce interest payments, or increase the loan amount whenever businesses see growth opportunities that require additional capital or more flexible debt structure.
d. Treasury Management Not Required
It is surprising to know that most big banks don’t earn large profit margins off their loan services as they make most of their earnings from treasury management. Non-bank lenders make it easier for businesses to maintain treasury services with their incumbent lender as switching services can be a time-consuming process.
e. No Credit Financing
Consider a non-bank lender if you have been denied by a traditional institution. There is a higher chance that they will grant a funding request for businesses or individuals with not so good credit ratings.
f. No Spending Stipulations
Since big banks require specific spending stipulation for a given loan, go for non-bank lenders as they give you flexibility to use the loan to whatever helps your business grow, thrive, and expand.
g. Mutual Relationship
Unlike dealing with big banks, non-bank lenders help you establish strong positive relationships by timely debt repayments thereby securing lower interest rates in future loans.
Even with the inherent advantages of working with non-bank lenders, business owners need to understand the shortcomings as well.
a. Higher Interest Rates
Unlike traditional banks, non-bank lenders tend to suffer higher credit losses so they end up charging higher cash-on-cash interest rates (including payment in kind) to improve total returns.
b. Higher Prepayment Penalties
Many non-bank lenders want their capital allocated in a way that aligns with the duration of their investment structures. They satisfy such needs by including prepayment penalties that increase the cost of switching for borrowers looking to refinance in a shorter turnaround time.
c. Equity Sweetener Requirements
Most of the time, non-bank lenders participate in deals when equity sweeteners are in play. Although it can be seen as a positive indication of finding a long-term lending partner, many businesses would still consider the downside of equity dilution. It is interesting to note that the asset-based lenders are exceptions to the rule.
d. Minimum Loan Amount
Leaner organisational structures can effectively reduce transaction times thereby cutting the bandwidth of the lender. As such, many lenders have implemented a screening criteria that included a minimum deal size to ensure that such efforts result in efficient capital deployment relative to resource intensity. Loan sizes are often between $2 million to $5 million.
e. Lender Bankruptcy
There is a chance that a non-bank lender would go bust especially if they’re a new industry player. Just like any business relationship, it is important to do due diligence on the lender before signing a contract.
f. Hidden Fees
There may be some hidden costs like disbursement or repayment fees you may not know about so make sure to find out these numbers before signing a contract.
g. Non-Guaranteed Early Repayment Discount
Depending on the lender, there are those that won’t give a discount even if payments are made earlier than requested.
Is a Non-Bank Lender Right for You?
Once you understand the pros and cons of working with a non-bank lender, here is a simple checklist you may use before considering a lending partner:
Substantially-larger loan than a traditional bank can offer
Flexible loan structure
$2 million to $100 million in debt capital
Slightly higher interest rates
Less onerous covenants
Reduced equity dilution
More than $3 million in projected EBITDA this year
Weak balance sheet or assets below 10% of requested loan amount
More than 50% of employees in Australia
Backed by private equity and institutional investors
There are many business funding alternatives suited to your needs that are available in non-bank lenders in Australia.
a. Short Term Loans
Suited for temporary cash flow problems, short term loans can be obtained via credit cards, payday loans, and invoice finance via invoice discounting, factoring, and supply chain finance.
b. Long Term Loans
Some small businesses may want to obtain longer-term funding or investment in order to achieve more ambitious growth and expansion plans as well as new product development. Non-bank lenders are good funding sources for small businesses since they are willing to invest in riskier ventures. On the other hand, equity finance provides needed investment in exchange for company shares or future profits. This could be through angel investors, venture capitalists, or share issuance.
c. Asset-Based Loans
Also known as asset-based financing, money is loaned to businesses bound to an agreement secured by collateral like inventory, accounts receivable, equipment, or other property owned by the borrower. Usually, businesses have to take out loans or obtain lines of credit to meet routine cash flow demands.
d. Business Lines of Credit
Some businesses look for a more flexible financing option on an on-demand basis. That means, you only borrow however much you need, when you need, up to an approved limit. You just have to keep the loan balance below the credit limit and decide how often and how much you are going to pay off. It is best suited for a wide-variety of business purposes from financing investments to short-term working capital.
e. Merchant Cash Advances
Also known as “credit card receivable funding,” this type of funding allows your business to borrow money based on your existing merchant account sales. The non-bank lender will then advance funding that you have to repay with a percentage of your future merchant sales (credit card and EFTPOS). It is an alternative funding option for small businesses as the lender purchases your future transactions and advances payment for future sales. This is ideal for businesses, like retail shops, cafes, and restaurants, with high turnover but low cash on hand.
The non-bank lenders are entities that provide bank-like services but never fully a bank as they are not regulated by federal and state governments. Many of them exist as investment banks, hedge funds, private equity funds, insurance companies, P2P lenders, mortgage lenders, and money market funds.
They play a huge role in financing a lot of Australian companies that help fuel economic growth since the global recession a few years ago. In fact, more small- to mid-sized level companies are now looking to work with non-bank lenders to fuel their post-pandemic growth apart from spending from their own funds.
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