Money talks

Money makes the world go round. But for many companies, not least those in the manufacturing industry, in the last two years the world will have nearly stopped turning. The recession has provided a spiteful reminder of just how important it is to have access to finance and smooth cash flow.

The Bank of England’s latest quarterly Trends in Lending report, released in October and presenting figures for August, the latest figures available, says that the major high street banks and building societies increased net lending in August by £0.3bn. However, although the deficit is decreasing month by month, lending to businesses is still 5.4% down on lending 12-months earlier. In addition, total lending has been lower than repayments for the past six quarters.

The most recent figures available from the British Bankers Association (BBA) for bank and building society lending to small businesses – defined as those with annual bank account debit turnovers of up to £100m – show that new lending in September 2010 was roughly at parity with the same month in 2009 at a total of £564m from 10,000 loans. In total, small businesses owed banks £45.3bn at that stage. The BBA says that lending to small business contracted by 5% between August 2009 and August 2010. Indicating that this could be demand-driven, the Department for Business, Innovation and Skills (BIS) found that demand from small businesses for loans, from all sources, was down 7% over that period by number of loans and down by 3% by value.

The Government set the banks that were bailed out by the tax payer – Royal Bank of Scotland and Lloyds Banking Group – a combined target of £94bn lending to businesses this financial year, where £45bn must go to small businesses. In their half year interim reports, both banks reported good progress with RBS saying it had lent £30.9bn of corporate loans and Lloyds £35bn. But it should be noted that when the target was set by the then Chancellor of the Exchequer Alistair Darling, the figure was to be made up of gross lending. Secretary of State for Business Vince Cable has since changed this so that the target includes net lending, meaning that loans that have been repaid count towards the total.

Finance types: What is popular?
Deloitte’s CFO survey for Q2 2010, conducted in June, found that bond issuance – for those companies large enough to qualify – curries most favour as a means of raising capital, followed by bank loans and then equity issuance. While the metric Deloitte uses is ‘attractiveness’, it is inconclusive whether CFOs are basing that attraction mainly on the cost of borrowing alone.

Peter Russell, head of manufacturing sector at RBS Corporate and Institutional Banking, says the banks have favoured asset-based funding options for much of 2010 as they are capital efficient tools.

There are benefits for companies too, he says; primarily that more can be lent against any given pool of capital that an ordinary loan facility and there is flexibility to renegotiate for larger facilities mid-term.

Russell predicts that there will be an increase in investors looking to put money into potentially high growth companies as they look for better returns than they would get by squirreling away cash in savings accounts.

“We can expect new entrants in the [financing] market, and not only banks,” says Russell. “For example, insurance companies with capital to invest may choose to target certain sub-sectors and/or types of assets. Also, equity funds, which are attracted to fast growth companies operating in high value, defensible markets, are likely to feature more prominently.” EEF’s research from the Shape of Industry report finds that significantly more small companies will look to use asset finance and invoice finance than medium and large companies, who both registered a similar demand for these two types of finance (see table). Young companies are more than twice as more likely to use asset finance than the average business (by age). However, all firms still see medium term debt over one to five years as the most likely option.

Over 80% of companies in EEF’s survey said they plan to use a range of funding channels, with half quoting two to three sources of finance and a quarter naming four to five sources.

Tools for machine tools
Leasing is increasingly being flagged in some quarters as a better finance option for buying new machinery up front. Independent asset finance company Bluestone Leasing says its new business has increased by 80% over the last year, with a large part of that attributed to manufacturers. Companies big and small have turned to leasing, Bluestone says, and its customers even include public sector bodies.

Chief executive Phillip Bennett says: “Leasing has many advantages over bank loans, overdrafts, remortgaging or even cash. Monthly fixed repayments make budgeting simple and the lack of default clauses means that, so long as you keep paying the rent, you can sleep at night without worrying that the bank will reduce your facility or pull the plug for reasons beyond your control.

“Moreover, the lessor will only take security over the asset itself and not the whole business. This is a great comfort and even if a personal guarantee is required it is limited to the amount of the funding and is, in my experience, much less onerous than the typical bank guarantee.” Andy Curran, director of Finance for Industry, a company which specialises in providing finance only for machine tools, predicts that leasing will become even more popular next year for tax reasons.

“Capital allowances are set to be reduced from £100,000 first year allowance to £25,000 in April 2012,” he explains. “If you buy machinery up to £100,000, at the moment you can offset the entire amount against your tax. When the change becomes effective, you’ll only be able to offset the first £25,000 in year one. However, by leasing instead of buying, companies will be able to offset each individual rental payment and therefore the entire cost can be offset against the tax bill.” Currently, hire purchase agreements are Finance for Industry’s most popular product. However, Curran expects leases to become more popular sometime in 2011, ready for the Capital Allowance change next year. He says his company has also seen a massive increase in business during the last 12 months and he puts this down to its focus on a specialist area of finance.

“The banks have tightened up their credit facilities and asked for additional security from their customers because they don’t always understand the value of machines and therefore they don’t recognise which of them, as assets, are more likely to hold their value. I don’t blame them because I don’t understand trucks or plant for instance, but I do understand machines and this means I can lend more money and offer better terms against them.”

The name is bond
A more novel way of raising capital is ‘minibonds’.

Popular in Germany where around 70 were issued last year, they are unlisted bonds issued by a company which return a fixed rate of interest after a predetermined period. At least three companies in the UK – King of Shaves, Ecotricity and The Chocolate Tasting Club – have embarked on such programmes thus far. King of Shaves was in the first in 2009 and raised £600,000 from its scheme.

Ecotricity’s issuance, based on a fouryear term at 7%, ended in December and the company is yet to state how much of its £10m target it has raised.

The Chocolate Tasting Club, owned by Hotel Chocolat, aimed to raise £5m through its scheme but, in this case, investors don’t expect any monetary profit. They will get chocolate, though. Members usually pay a fee of £20 per month to receive luxury chocolate boxes.

If they invest either £2,000 or £4,000 up front their member fees will be wiped and over three years they’ll get boxes to the value of their investment plus 6.72% or 7.29% per year in chocolate interest.

After three years they can redeem the bond for the original value.

Action to inspire lending
Whatever the statistics, the consistent message from the banks throughout 2010 was that money is available to borrow and that they are keen to work with industry to find mutually beneficial ways of opening channels. And now the banks have presented a united front and put that commitment in black and white. The UK’s six largest banks – Barclays, HSBC, Lloyds Banking Group, Royal Bank of Scotland, Santander and Standard Chartered – created a Business Finance Taskforce (BFT) in response to government’s green paper, Financing the Private Sector Recovery, released in July 2010.

In October, the BFT detailed 17 actions across three broad areas which they say are designed to “help businesses thrive and grow”. In addition to adhering to Business Secretary Vince Cable’s instruction in the green paper that an independent appeals process should be put in place for when loans are declined and committing to laying out guidance principles for how transactions between businesses and banks should be conducted, the BFT says it will commit to initiating dialogue with companies 12 months before finance deals are due to end. This will include reviewing the businesses performance and prospects at that point in time and making recommendations for actions to maximise chances of refinancing.

Under its ‘Ensuring better access to finance’ pillar, the BFT commits to a creating new £1.5bn Business Growth Fund. Aimed at funding growing companies in the £10m to £100m turnover range, the fund will provide investments from £2m to £10m with the lenders receiving an equity stake in the business which will be redeemed after five years.

It also commits to continued support for the Enterprise Finance Guarantee scheme, a loan scheme first set up in January 2008 which sees government act as guarantor for 75% of commercial loans between £1,000 and £1m with the bank backing the remaining quarter. The scheme has how been extended to run for a further four years and the Government has committed to guaranteeing a further £2bn over that period.

Finally, ‘Providing better information and promote understanding’ contains several actions designed to make the banking industry and its performance more transparent and to open up new channels of dialogue with business to tackle bottlenecks and barriers to finance.

As chairman of the BFT, John Varley, chief executive of Barclays, said: “As banks we have an obligation to help the UK economy return to growth. The private sector will play a key role in the recovery and it’s our job to help viable firms to be successful. SME s are particularly important as a source of job creation and growth. We look forward to working with the authorities and with business groups to take these initiatives forward.” EEF commended the action points, noting specifically the publishing of lending principles, and urged the Taskforce to pay particular attention to creating transparency between businesses and banks.

“The rules have clearly changed for both banks and businesses and hopefully we will now see some common ground between what the Taskforce is proposing and the needs of businesses through the recovery,” says EEF director of policy, Steve Radley.

Recommendations
In mid-2010, NatWest’s chairman of small businesses Peter Ibbertson said in light of the high levels of bank bad debt that have had to be written down – one of the key contributors to the global recession – businesses now need to provide highly detailed proposals in order to convince the bank to lend them money.

“If you’re a manufacturer looking to do something three or four months down the line, the key thing is come and talk to us now,” he said. “Involve us in those debates and talk to us about your cash flow. It’s a much better way than turning up at the last minute. It may be that traditional loans and overdrafts aren’t necessarily the best way to fund.” As a part state-owned bank, he pointed out that it would be irresponsible for RBS to lend money without more early transparency, especially given that, bonuses aside, much of the public furore aimed at the banks when the crisis began was fuelled by allegations of irresponsible, ‘casino-style’ lending.

A local approach
Chief executive of the Manufacturing Advisory Service West Midlands, Simon Griffiths, meanwhile, has called on banks to reintroduce business bank managers to local companies in order to increase commercial lending, as he says they are likely to be able to make better judgements about which businesses would be reliable debtors.

“In the days of a local manager he or she had such good working relationships with their customers and could spot a winner when one came along,” he says, contending that the centralised system banks now adopt for lending could mean that some companies worthy of investment are overlooked.

Responding to the action points of the Business Finance Taskforce, the Black Country Reinvestment Society (BCRS) – a Community Development Finance Institution (CDFIs) – released a report of its own, A Co-operative Approach to Small Business Lending, which included several recommendations for a ‘co-operative approach based on mutual principles’.

The BCRS suggests that the banks, large companies, high net worth individuals, the Regional Growth Fund and local authorities should all contribute to and become stakeholders in local funding pots which would be disseminated by the CDFIs who then bear the risk of the loan or loans.

As CDFIs are entitled to Community Investment Tax Relief, the finance becomes cheaper for the lenders and the borrower. Banks will hold the accounts meaning they are introduced to new customers that are potentially high growth companies – a prerequisite for them receiving the money. Under this model, it is the businesses’ growth potential that is used as security, rather than fixed assets, which takes away one of the main barriers to accessing finance that small and start-up companies often hit.

EEF has also called for more non-price competition between banks to drive lending, something also flagged in the Financing the Private Sector Recovery green paper.

Another idea, under the moniker Project Merlin that is also being headed by Barclay’s John Varley, suggests that the tax on bankers’ bonuses is partly determined by their bank’s lending to small businesses.

Looking inwards
If the usual channels for financing do not bear fruit, manufacturers may be able to look internally at their own processes and find that they can self-fund their needs with a few changes in their financial management. OnGuard, an independent Dutch software company, has developed predictive analysis software which helps companies better control their invoice payments and allows them to see where cash flow bottlenecks could arise in advance.

“We supply software that allows companies to streamline their accounts receivable, meaning they don’t have to go to the bank capin- hand asking for money for investments,” says OnGuard CE O David Taylor. “Because of the downturn, some companies are taking as long as 60 or even 90 days to pay. Companies can free up large amounts if liquidity just by becoming more disciplined with how they get paid.” The predictive analysis software works by identifying customers which could be a risk in the future so that extra attention can be given to them.

Whenever interaction takes place with a customer, data is input into the programme, recording things like which dates were given for payment, whether that commitment was honoured and what the actual lengths of payment are. A scoring algorithm is built up for each customer. When timelines begin to slip or promises are broken, the score becomes negative and the account is flagged up with the customer so that they can make contact and devise another plan for the relationship, or perhaps a more experienced client manager is assigned to the case.

One of OnGuard’s clients in the Netherlands had Eu3 million outstanding on invoices over 120-days old. With the help of the software it now has just Eu500,000 in debts over 60-days.

“In previous recessions companies would always just go to the banks and ask to borrow more money,” says Taylor. “Today, that might not be possible. The money is sitting around with customers; all you need to do is encourage them to pay earlier.”

A brighter horizon?
Of note is that EEF’s research says finance appears to be low on manufacturers’ grievance lists. Taking businesses of all sizes, only 30% of companies who are looking to grow cited the availability of affordable finance as a barrier to their ambitions.

This figure dropped to 15% for those companies that were simply looking to maintain their market position. Finding appropriately skilled employees, communication with suppliers and customers, availability and cost of raw materials, and management capability were all cited as stronger inhibiting factors than finding finance.

That isn’t to say that finance is not a serious problem for some companies even in a recovery cycle. Begbies Traynor’s Red Flag Alert research finds that 123,361 UK companies were experiencing ‘significant’ or ‘critical’ financial problems in the third quarter of 2010, 5,353 of which were manufacturers, although these figures were respectively 10% and 9% down on the same period a year before.

But, as has been seen, credit conditions do appear to be easing, and businesses are looking at new and innovative ways of funding their businesses to complement the usual channels which bank lending offer. The banks, for their part, have been vocal in sending out clear messages that not only do they want to lend but that, through initiatives like the Business Finance Taskforce, they are committed to finding ways to improve the corporate finance landscape.