Top Risks and Protections in Private Credit Lending for Small Businesses
Every year, one in six small and medium enterprises seeks finance to fund or grow their operations. A growing number of these businesses are turning to private credit as a lifeline.
Statistic obtained from Small business access to finance, Productivity Commission.
For many, traditional bank lending has proven too slow, inflexible or reliant on property security. In response, non-bank and private lenders have expanded their offerings, creating more ways for small and medium enterprises (SMEs) to access funds.
But with opportunity comes risk. Non-bank lenders operate outside the same regulatory perimeter as banks. Contracts are often standardised and presented on a “take it or leave it” basis. Costs are typically higher and funding structures can be fragile. At the same time, small businesses are often under-resourced to properly assess contract terms, credit risks or long-term obligations.
At Empirical Legal, we specialise in helping businesses navigate these risks. For small businesses considering private credit, understanding the risks and knowing what protections exist is critical.
This article sets out the top risks in private credit lending for SMEs, with a focus on protections available under Australian law and regulation.
Summary of Key Risks and Protections
Small businesses need to be aware of four main areas when dealing with private credit:
Unfair contract terms: Since 2016, small businesses have been protected from unfair terms in standard form financial contracts. Courts can void unfair terms, impose fines and order refunds (ASIC Information Sheet).
Non-bank lending risks: Non-bank lenders account for only 5% of the financial system but their lending has grown at nearly three times the pace of banks since 2015. Costs are higher and protections weaker (RBA Bulletin).
Innovation finance challenges: SMEs are now the engine of innovation in Australia, accounting for 55% of R&D spending but face survival risks, collateral barriers and “valley of death” funding gaps (RBA Brad Jones speech).
Evolving protections and opportunities: New lending products, including unsecured options, have widened access but small businesses must carefully assess contract terms, lender reliability and suitability (Small business access to finance, Productivity Commission).
Unfair Contract Terms: The First Line of Protection
Australia has around 2.4 million SMEs employing more than 7.4 million people (Small business access to finance, Productivity Commission). Many of these businesses rely on credit contracts to secure loans, insurance or financial services. The majority of these contracts are drafted by lenders, leaving little scope for negotiation.
The risk? Unfair contract terms that heavily favour the lender.
Since November 2016, the unfair contract terms law has applied to small business financial contracts. For insurance contracts, the law applies to contracts entered into or varied on or after April 2021 (ASIC Information Sheet).
A contract is covered if:
One party is a small business (employing fewer than 100 staff or with turnover under $10 million);
The contract is for a financial product or service; and
The upfront price does not exceed $5 million.
A term is considered unfair if it:
Causes a significant imbalance in rights and obligations;
Is not reasonably necessary to protect the lender’s interests; and
Would cause financial or other detriment to the small business if applied.
Examples of unfair terms include:
Allowing the lender to vary interest rates unilaterally.
Forcing the borrower to accept liability for events outside their control.
Preventing the borrower from challenging terms.
If a court declares a term unfair, it is void. The rest of the contract continues if it can operate without that term. Lenders that continue to rely on void terms risk fines, injunctions or refund orders.
Small businesses are not powerless. They can complain directly to the lender, escalate to the Australian Financial Complaints Authority (AFCA) or apply to court. ASIC can also take enforcement action in the public interest.
Non-Bank Lending Risks: Higher Costs, Faster Growth
Non-bank lenders now account for around 5% of the Australian financial system (RBA Bulletin). While this share is small, the growth rate is striking. Since 2015, non-bank housing lending has grown at an annualised pace of almost 15%, more than twice that of banks.
Non-banks play an important role in serving borrowers that banks overlook. They offer faster loan turnaround and are often more flexible on documentation. But these advantages come with risks:
Higher borrowing costs
Between 2019 and 2021, non-bank housing loan rates averaged 60 basis points higher than the housing loan rates of major banks. In 2022, the gap widened to 100 basis points as non-banks faced higher funding costs in securitisation markets. For businesses, the gap is even larger because non-banks often target riskier sectors.
Riskier lending profile
Non-banks lend more to self-employed borrowers, those with less documentation or those in industries sensitive to economic shocks. While loan arrears are currently low, the average borrower profile is riskier than at banks.
Funding fragility
Non-banks rely heavily on securitisation and warehouse facilities provided by banks. During times of stress, such as the global financial crisis or COVID-19, these funding sources can dry up. Although banks’ exposure to non-banks is only around 1% of total assets, any stress can flow back into the system through funding channels.
Regulation gap
Unlike banks, non-banks are not prudentially regulated by APRA. While market discipline and investor oversight provide some checks, SMEs dealing with non-banks should understand that protections are weaker.
Non-bank lending offers speed and access but at higher cost and risk. SMEs must weigh these trade-offs carefully before committing.
Innovation Finance: The SME Challenge
SMEs are the engine of the Australian economy. They now account for 55% of total R&D spending, about 25% more than large firms (RBA Brad Jones speech). They also hold almost all patents and trademarks filed by Australian residents. Despite this contribution, SMEs face significant hurdles in accessing finance.
Survival risks
Small firms are more likely to exit the market each year than large firms. Survival rates for young small businesses are particularly low, reflecting the “up or out” stage of development where firms either succeed quickly or fail (RBA Brad Jones speech).
Collateral barriers
Most SME loans require property as security. This leaves many younger entrepreneurs, especially those not yet on the housing ladder, unable to access loans. Even when property is available, many are reluctant to risk their home as collateral, leading to more risk-averse business decisions.
The “valley of death”
Innovation often involves long timelines before revenue is generated. Research, prototyping and commercialisation can take years. During this period, businesses burn through initial funding without cash inflows. Lenders are reluctant to finance these gaps.
Banks’ reluctance to finance innovation
Surveys confirm that banks are much less likely to finance innovation investments by SMEs compared with large firms. Instead, SMEs rely more heavily on family, friends, venture capital and private lenders.
The result is that innovative SMEs are pushed toward higher-cost private credit markets at precisely the stage when their survival is most fragile.
SMEs drive innovation in Australia but face structural finance barriers. For those turning to private credit, careful planning and legal advice are essential.
Evolving Protections and Opportunities
Despite these challenges, the lending market for SMEs has improved over the past decade. According to the Productivity Commission, technology and new business models mean that more lenders can now extend credit without relying solely on property as collateral.
This matters because:
SMEs without property security can now access finance;
Loan approvals can be faster, allowing businesses to seize opportunities; and
Competition is increasing, giving SMEs more choice.
Private lenders and fintechs are using transaction data and advanced systems to assess creditworthiness quickly. Some even offer unsecured loans, reducing reliance on collateral.
But risks remain. SMEs may not fully understand the variety of products available or may be hesitant to trust newer providers. Brokers can help match businesses with suitable products but the need for careful contract review and legal advice remains.
The expansion of options gives SMEs more ways to fund growth but protections like unfair contract term laws, AFCA complaints processes and ASIC oversight remain critical to ensure small businesses are not exploited.
Key Takeaways
Private credit lending is reshaping the SME finance landscape in Australia. The opportunities are real but so are the risks.
The top risks are:
Unfair contract terms in standardised financial contracts;
Higher costs and fragility in non-bank lending markets;
Structural finance barriers for innovation-driven SMEs; and
Rapidly evolving products that require careful assessment.
The protections are equally important: ASIC’s unfair contract terms law, AFCA’s dispute resolution, court powers to void unfair terms and the growing role of competitive finance options.
Empirical Legal is a corporate advisory and technology law firm for startups, scaleups and SMEs.
We combine legal, technology, and business experience and expertise to deliver practical, actionable advice and solutions.
At Empirical Legal, we help SMEs secure finance safely. We combine legal expertise with commercial understanding to ensure that contracts are fair, risks are managed and opportunities are maximised. If your business is considering private credit, contact us to ensure you’re protected.
Reach out to Empirical Legal today.