Debt load of businesses seeking finance is double pre-Covid level

The indebtedness of businesses seeking finance is more than double the pre-pandemic level, a study of thousands of loan applications has found.

The average debt-to-turnover ratio of small companies seeking loans “appears to have settled”, a report by Funding Xchange concluded, but at a level that undermines many businesses’ chances of securing finance.

Access to finance remains “stubbornly below” pre-2020 levels, particularly for working capital, the company’s quarterly lending monitor found.

Funding Xchange is a marketplace that links businesses and funders outside the mainstream banks. Its research, based on thousands of loan requests, identified a shift in the profiles of prospective borrowers towards companies that are “not ready to take funding or can’t afford additional lending”.

Funding Xchange added that it was seeing more applications that were “no longer primarily about fuelling growth — but survival”.

Cash reserves that had provided a buffer during the Covid years have dwindled, with median balances now below pre-crisis levels.

Funding Xchange said that the shift in prospective borrower profiles to companies that are less likely to be accepted had been driven by the tens of billions of pounds worth of additional debt being taken on by businesses during the pandemic. The UK government’s support was the most generous in Europe, it said, with about one in three British companies taking on an emergency loan, compared with closer to one in ten in France and Germany. Uptake was particularly high among the smallest firms.

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While the report said borrower readiness and affordability were the “real barriers” to borrowing, rather than limited supply of financing, it added that businesses appeared to require stronger financial health than at any time in the past decade to successfully access funding.

Last month a report by Allica Bank, a lender, said that a “heavy shift” towards low-risk lending backed by property, including residential mortgages, had resulted in a dysfunctional business finance market.

UK bank lending to companies had fallen “well below the historic trend”, Allica said. Lending to small or medium-sized enterprises was £90 billion lower than it would have been had it followed levels recorded between 1997 and 2004.

Funding Xchange noted that borrowing has also become significantly more expensive. The UK’s base interest rate is higher than the eurozone’s, meaning that “UK SMEs are not only more indebted than their European peers — they also face higher costs to service that debt”.

It said that more businesses being turned away was exacerbating a long-term trend in which British companies permanently turn their back on external finance, which could have implications for business investment and productivity.

Katrin Herrling, chief executive of Funding Xchange, said: “Based on our experience, the impact of the negative experience can be long lasting. Businesses believe ‘they are not good enough’ [and] will forgo applying for finance in the future.”

More start-ups are seeking funding, the report found. Since most lenders require at least two years of trading history and full accounts, this has led to a higher rejection rate.

The report called for “greater transparency” to help businesses understand why they have been turned down for funding.