Mar 23 2012 By Mike Parkinson
Define your terms – banks will lend, but in 'perfect storm' conditions it's a choppy ride.
BORROWING money has never been harder for small firms, or more necessary for many. Yet there are still few practical signs that banks want to do much more than lend to businesses that hardly need it, whatever the warm words and encouragement from Government. Whether the budget and the new National Loans Guarantee Scheme actually help remains to be seen.
What are the options for the struggling business owner? One is to consider debt or equity funding. The former has the advantage that no control is surrendered. But it may involve offering security or personal guarantees.
The key is to make sure that long term loans are used to finance long term acquisitions, while overdrafts help with short term working capital. Equity finance involves the raising of share capital from third parties. This does involves the loss of at least partial control, but gives investors potentially greater returns than interest provides because they share in your risk.
It also makes sense to see what other finance might be available, and to explore less travelled paths. There are grants for specific tasks, such as Enterprise Capital Funds, which aim to help new business ventures. Friends and family may also be able to help on favourable terms.
But somehow it all comes back to banks.
There has been understandable criticism of them for being, in the words of one of my clients, 'keen to sell you umbrellas when it’s sunny, not when it’s raining'.
There is also a view that even when lending, their rates are too high – average interest was lower in 2008 when the base rate was 5 per cent than it is now at 0.5 per cent - and more security is being demanded.
Despite headlines about the success of Project Merlin, the agreement between government and banks intended to boost commercial lending, of the £214.9 billion lent, only 74.9bn went to smaller firms against what was meant to be a pretty soft target of £76bn.
To be fair to banks, which is not a fashionable activity, part of the shortfall can be blamed on some firms wanting less credit, preferring to repay debt in a recession rather than reinvest.
But still, the nagging view is that banks are dragging their feet and are less the partners they once were to 'Enterprise UK'. It is clear from many cases I hear about that the SME relationship manager at the bank generally tends to be supportive of their customers' requests for loan or overdraft facilities but that such requests are often thwarted when proposals are submitted to the bank’s credit team for approval.
One consequence of this is that small businesses are being pushed into invoice discounting, a form of short term borrowing that allows a business to draw money against its sales invoices.
But it can be expensive compared to a loan or overdraft. Clearly, the amount borrowable rises with sales, but a drop in sales will mean that amount falls, often at precisely the time when the money is needed most.
Hardly ideal. Owners are also often required to put in ‘hurt money’: guarantees ensuring they face some pain if the loan goes sour.
Our experience suggests that banks are also now far more aggressive in responding to minor breaches of covenants, using them to levy penalty charges or increase interest rates.
In the worst case, external monitors are appointed and must be paid for by the borrower. It used to be possible for borrowers to take capital repayment ‘holidays’ when times were tough. This is rarely available now.
The sad reality is that the demise - principally for security enforcement reasons - of the much cherished overdraft facility has created a ‘perfect storm’ for small businesses of borrowing in the good times to fund growth, followed by inability to pay off as sales drop, then invoice discounting automatically reducing as sales disappear.
There will always be a 'them and us' mentality between bankers and their smaller business clients. But that divide seems to be greater now.
On the one hand, banks would like businesses to tap into the expertise they have, but on the other many small businesses view banks as no more than a necessary evil.
From our vantage point as advisers, it is clear that banks do want to lend but on their terms.
The plain reality is that those terms are not as generous now as they were historically, and they may never be so again.