Small and Medium Sized Enterprises, Owner Managed Businesses, small companies – call them whatever you wish – but there is no doubt they have been disproportionately affected by the credit crunch. Banks have preferred the safer haven of larger companies, especially in the quoted sector, which are historically and inherently less risky than smaller private companies. Even after the excesses of the mid 2000s, banks still have significant amounts of money to lend. But they are much more selective about who they will lend to and for what.
Their criteria for lending are much tougher than before the credit crunch. That is going to continue. The cost of bank debt is much higher. That is going to continue. Scarcity of capital, achieving better risk/return balance, banks’ cost of capital, banks’ need for better profitability from traditional lending and other traditional banking activities – all these will mean that bank lending to SMEs will be more difficult and more expensive. This will continue.
The style of lending has also changed for the foreseeable future. This will also continue. Medium term loans are in; overdrafts are out. Security is in; cash flow lending is out. Covenants are in and will be monitored very tightly. Previous relationships may help, but don’t expect much. Alternative sources of debt will become more prevalent. Banks will be offering asset-back lending like Hire Purchase and Leasing, but those offering this will be more selective and more expensive. Independent invoice lenders will also play an increasing role in the SME market. There may however be a risk of some bad debts in this area as the rapid growth of this type of lending will harvest its lemons, causing a bit of a pause in these lenders’ appetites. Other sources of finance will come to the fore, including Angel Investors and Private Equity funds in a variety of guises, more recent initiatives such as the Scottish Loan Fund and the Business Growth Fund, as well as innovative pension funding via SIPPs and SSAS’s. We will also see the emergence of broker-like arrangements where intermediaries promise to match lenders to potential borrowers, although these are likely to be abused and short lived.
What does this mean for the Privately Owned Business?
Quite simply finance will be harder, and take longer, to raise, and it will be more expensive as well. The capital available will be channelled to the best businesses with the best propositions and the best risk/reward returns for the lenders/investors. This will be capitalism in the raw. The strong will get stronger and the weak will struggle and be starved of the capital they need. And even if your business has weathered the last 4 years of the storms and is now winning more orders, don’t take for granted the level of lending that you would previously have expected.
So, what to do?
- Get your business into shape. Even if you think you’ve done it already, critically review your business again – every facet, from marketing and sales to operations and finance. Make sure you are as efficient and productive as you can be.
- In the same way as lenders/investors will only back the best, most profitable businesses, make sure you invest your precious funds only in the most profitable, cash generative projects.
- Make every function in your company compete for resource
- Don’t be a cheap lender to customers who can’t afford the rates that banks are charging. Remember you are an unsecured lender, so your return should be much higher. Make sure your working capital is tightly managed.
- If you are raising money, make sure you raise enough – too much even. In 30 years of advising SMEs I have never seen one which went bust because it had too much money.
- Match your borrowing profile to your assets profile. If you are invested in long term assets, finance them with long term money. Better to have too much long term money than too little.
There is no doubt that this is a challenging time for SMEs. However, those that get their house in order early will reap the rewards. Equally, those that are open to alternative sources of finance, such as mezzanine debt, equity or SIPP funding, will perhaps find more avenues available to them.
It is important that Principals take an objective view of their business, and their finance requirements. You can be sure that potential funders will do so, without any emotional attachment. Craig Corporate would be delighted to offer such assistance, providing the opportunity for Privately Owned Businesses to approach funders on the front foot.
And get your business in to shape. Lenders and investors will be very selective. Oh, did I say that already?