Shaun Hyland, debt advisory director at Leonard Curtis, explores the key financing trends that will define the coming months for UK SMEs and mid-market borrowers.

Before stepping into the 2023 predictions arena, it is probably worth glancing back over our shoulders at 2022 to see how we saw lenders react to any number of disruptive events, including the return of military conflict in Europe; ongoing global supply chain issues; rising interest rates; a continuing cost-of-living crisis; industrial disputes in the UK on a scale not seen since the Thatcher era; and the return of Brexit disquiet and domestic political turmoil.

So just when we thought that the problems of Brexit, the pandemic and the resulting restrictions on trade were history, you would be forgiven for thinking that 2022 brought a whole new level of risk to UK SME and mid-market borrowers.

At heart, all lenders are risk-averse, so the natural consequence of the above in 2022 was to exercise caution when reviewing new opportunities and to scrutinise existing relationships more closely to ensure they could weather the storm.  With no clear end in sight to many of the issues currently facing the UK, there should be no expectation of a return to freely available funding at low rates.

However, there is a significant amount of funding available to businesses that can present a robust plan and ability to navigate the choppy waters ahead, albeit often from lenders outside of the mainstream banks.  This will create an opportunity in terms of both demand and margin for lenders such as debt funds, family offices and other non-bank financial institutions.

Sectors that are closest to the consumer, such as retail or hospitality and leisure, will find it harder than many to source funds.  Some lenders will take the view that the sector is off limits but others will take a more enlightened approach that there will be winners and losers in every sector.

However, forecasts will be reviewed in more detail, in particular the sensitivity to further interest rate rises and the inflation impact on both expenses and revenues.

It is now approaching three years since Covid-19 appeared in the UK, bringing with it a series of lockdowns and trading restrictions as well as wholesale changes to working practices that still reverberate around the economy. The ensuing three years have left many SME and mid-market business owners exhausted and seeking an exit, which is likely to prompt a spate of activity in the M&A market in 2023.

For businesses that are stable and can be taken forward by a fresh management perspective, funding remains available if acquisitions are correctly priced and structured.

Covid legacy

The government-backed financial support schemes such as CBILS and RLS were well intentioned at inception but have left some businesses carrying a debt burden that is simply too great. This is especially pertinent for businesses that have also seen substantial changes to their market, often also brought about or accelerated by the pandemic. In many cases there is a viable business but one simply unable to trade through its debt pile, so we can expect to see a number of accelerated M&A processes, presenting further acquisition opportunities.

The introduction of the CBILS, with the government paying interest for the first 12 months and many lenders offering capital repayment holidays, saw a steady stream of businesses eschewing their invoice finance and asset-based facilities in favour of the scheme. Even where the debt accumulated under these schemes remains manageable, servicing an amortising loan is now an unnecessary cash drain when it can be replaced by the reintroduction of invoice finance, with or without other asset-based facilities.

In an environment where lenders generally are having to deal with a number of risks that simply cannot be controlled, secured facilities will prove far more attractive as they both increase returns on capital and improve the recovery prospects in the event that things do not go according to plan.  It should be no surprise therefore to see an increase in the number of asset-based lending facilities being announced during the course of 2023.

To summarise, lenders in the UK SME and mid-market spaces are starting to expect the unexpected after three years of turbulence. Some have watched issues in the portfolio become problems and need to deal with those before actively seeking out new opportunities.  Others however have been more selective about the clients they took on since the pandemic, are well funded and actively seeking to grow their loan books.

There can however be no doubt that the UK economy in general, and certain sectors in particular, are facing strong headwinds during 2023. Now blessed with greater experience, lenders will demonstrate a level of caution before committing.

Borrowers should expect rates to be higher, covenant tests to be a little sharper and a greater focus on security and downside protection. But for strong and stable businesses, 2023 will present opportunities for growth and acquisition that will find a willing and supportive lender… if you know where to look.