Making the right choice

Despite the economic outlook, many UK-based manufacturers have exciting plans for strategic development in 2012. Peter Russell of Royal Bank of Scotland looks at some of the options for funding available to SMEs and mid-sized businesses.

Identifying and accessing the right kind of finance remains a key consideration for manufacturing businesses looking to invest in a range of activities including new plant or property, product development, innovative production techniques or entry into new markets. Factors such as business strategy and longer term objectives will help to determine whether those investments are best funded via debt, equity or a combination of solutions.

Equity: a fair exchange for added strength

Among management teams in many mid-sized businesses, yielding equity in exchange for investment might be considered a no-go area. But with some entrepreneurs and businesses unable or unwilling to take on more debt, it’s an option manufacturers may want to consider in 2012.

Accessing public markets is not currently a realistic option for many companies so alternative sources of finance are a worthwhile consideration. For example, the government’s Business Growth Fund (BGF), now up and running, provides an alternative equity route for those looking for solutions to finance the future growth of their organisation.

BGF invests long-term capital in ambitious companies, in return for a minority stake, while also providing expertise and contacts. Operating as an independent company in its own right (with funding from the major UK banks, including RBS), BGF has £2.5bn to invest in business.

Aimed at organisations with turnovers of £5-100m (with typical investments of £2-10m), BGF provides a new option for senior management teams wishing to retain control of their business, in many instances complementing funding provided by conventional bank debt. If a broader re-balancing of how British industry is financed is to be achieved, it may well be that companies eligible for BGF funding will find the mechanism and benefits appealing, especially those with sound business ideas but without balance sheet headroom to take on extra debt.

A key differentiating feature of BGF’s offering – in comparison with some private equity (PE) options – is the minority equity stake it takes, accompanied by board representation. BGF says that investing from its own balance sheet also means it is likely to stay with the companies in which it invests for longer periods than some PE firms might typically prefer. According to Mark Bryant, a BGF director, “Those individuals we’d seek to be appointed as non-executives to boards are senior industrialists, business leaders or entrepreneurs themselves, with expertise and networks they’ll share with company management.’ Companies must meet certain criteria to be considered, but those who don’t yet tick all the boxes are not ruled out indefinitely. “We maintain a substantial shadow portfolio of companies,” says Bryant.

“We maintain contact with management and track their progress, paving the way for investment when they’re ready, or else signposting them elsewhere if it becomes clear that other funding solutions would be more appropriate.”

BGF funding is by no means a stand-alone option. Already, combinations of bank debt and BGF equity have provided solutions to companies who were reluctant to over-expose themselves in the event of difficult trading conditions. For organisations where equity solutions are appropriate, BGF funding may represent a welcome long-term option that allows them the time and freedom to pursue their objectives, growing their business organically or acquisitively as they see fit.

Lending-based solutions: a matter of need, strength and purpose

Attractive new alternatives to raising capital may increase capacity to invest; however, traditional loans and overdrafts continue to be critical for sustaining development among individual firms and the wider manufacturing sector. With interest rates on SME variable-rate facilities significantly lower than prior to the recession (according to the British Banking Association and the Department of Business, Innovation & Skills), debt remains a very attractive way to fund those activities designed to achieve growth. For SMEs and mid-sized Businesses, some of the short or medium-term lending options available today may hold more attraction than others. The nature of the investment to be funded, the financial strength of the business behind it and, of course, the term over which management wishes to borrow, will all be germane when weighing up these options:

The RBS Manufacturing Fund: Reserved solely for UK Manufacturers, through fixed rate loans, available on a three or five year term with capital repayment holidays of two years for each loan option. The overall cost for comparison is 4.00% APR for 3 years, 4.80% APR for 5 years. The fund provide companies with certainty, transparency and flexibility, when investing for growth.

Asset-Backed lending (ABL): an option to which more companies are turning, enabling them to access flexible finance for a variety of purposes, from capital purchases to working capital needs and all using the underlying fixed and current assets of the business as security.

Enterprise Finance Guarantee (EFG): In 2012, this scheme will open doors to finance for even more SMEs which don’t have sufficient security to satisfy the requirements of regular commercial loans for example where security is required. Until recently only available to businesses with turnover of up to £25m, the ceiling has been raised to £44m from January, with lenders benefiting from a 75% guarantee (for loans of up to £1m) from the government.

National Loan Guarantee Scheme: Announced by the Chancellor in November 2011, businesses with turnover of up to £44m shall be able to access funding at a reduced rate, as a result of government-guaranteed funding (up to a total of £20bn) to lenders. Details are being worked through now for actual launch in early 2012.

Pooling resources, playing to strengths

Some manufacturing mid-sized businesses may identify benefits from financing investments as joint ventures with other businesses, with everyone bringing something of value to the table, and all parties leveraging from pooled strengths, such as technical expertise, geographical connections or super-efficient supply chains.

Working with carefully selected partners may provide greater access to finance than might be attained if operating purely on a stand-alone basis, giving confidence to lenders and investors alike. For companies with overseas development plans, joint ventures might be especially appropriate where knowledge of distribution channels or access to support services and customer networks is crucial.

As 2012 pans out, the success of manufacturers seeking to grow amid continued economic uncertainty may depend as much on the funding options they pursue as the headline cost of this finance. With development activity more often consuming, rather than generating cash, at least in the early stages, directors and investors will need to judge the relative merits of taking on more debt against, say, opting to yield a degree of equity, in return for the most effective financing structure. Manufacturers should know that there is certainly a keenness to lend in support of the growth agenda, and a readiness to explore the wide range of options to support those with such plans.