Michael Pay, FCA, is Director of EMC Corporate Finance Limited, a leading corporate finance advisory boutique based in the UK. He is a Non Executive Director for a variety of companies and speaks regularly on business issues and blogs through http://michaelpay.blogspot.com/ .
In December 2011 he was a judge at Tech Entrepreneurs Week with Jimmy Wales, the founder of Wikipedia, Martin Warner, the founder of the TEW and various other pre-eminent corporate finance and business leaders.
“Show me the money!” is a presentation that he gave to the Turnaround Management Association (UK) in November 2011 about the problems of funding UK businesses.
In this presentation I am going to discuss the funding crisis that UK businesses are facing, looking at it from three aspects:
1. The debt and banking side;
2. The role of the VC; and
3. Considering some alternatives for delivering solutions to those problems.
Since 9th August 2007, the day that the credit markets froze and the subsequent run on Northern Rock in September of that year and, one year later, the collapse of Lehman Brothers the landscape for individuals, businesses and governments' has changed beyond recognition.
We are still living in unprecedented times with not just the fear of corporate failure and government or sovereign failure, but the potential for a whole region to collapse under its burden of debt.
Inflation is climbing and despite the bank of England’s stance on interest rate – the cost of borrowing is rising as evidenced by October’s increase in Lloyds TSB’s standard variable rate by 11 basis points.
The stock market is bouncing around like a yo-yo and currencies are difficult to predict.
Unemployment continues to climb as the UK Government’s austerity programme kicks and the private sector struggles to generate enough jobs to replace those being made redundant.
It could be viewed that the economy face the perfect storm...
Now against this backdrop the UK also faces unprecedented levels of debt as well.
We are not just talking about the government debt – which stands at £950bn – but the Net Debt that we as a nation – government, companies and individuals - owe the rest of the world. According to the OECD that stands at £7.2 trillion!
This UK net debt figure is very rarely discussed. When the government talks about National Debt (the £950bn) it is only talking about the government liabilities (excluding the banks, etc).
To put that in perspective, the difference is like admitting that you owe £10,000 on your credit cards and ignoring the fact that your partner and children owe a further £60,000 as part of the household total debt.
The country is in a fix and whilst the Government’s austerity programme may (or may not) help to stabilise the Crown’s situation, it still leaves an almighty hole in the country’s finances.
Whilst that historically did not cause a problem for domestic SME’s, the repercussions of the credit crisis and now the Eurozone’s sovereign debt problems has transpired to make borrowing more difficult for all of us and in many cases virtually impossible
What ever the type of funding that businesses engage with – overdrafts, loans, mortgages, trade finance, etc - the cost of borrowing is rising and the hurdles that have to be gone through to get credit approval is probably more difficult now than it has ever been.
Lenders – from Banks to Building Societies and from Lease Companies to Asset Lenders - are increasing the level of security.
Perhaps more relevantly, they are seeking better covenants on the assets that they are lending against.
This has resulted in a rise in personal guarantees on the one hand - supported by charges on property or similar assets on the other. The days when a personal guarantee was just a signature to agree to repay on default has long gone.
As politicians demand banks to lend to businesses and in particular SME’s, and businesses are finding it difficult to access money it is worth understanding a little of how we got to this position and why it is going to be almost impossible to get out of it...
According to the latest Bank of England’s Lending to UK Businesses report, published in September 2011, over the last 3 years UK businesses have been reducing the amount of borrowings that they have taken on.
From the heady days of 2007 and 2008 when net lending increased by £11.3bn over the two years to non-financial companies. 2009 saw a sharp reversal on 2008 with a reduction in borrowings of £3.9bn. This has continued through 2010 and appears to have an increasing rate of reduction in the first half of 2011 with a net reduction in lending of £3.0bn.
So, the bankers are being pilloried in parliament, in the press and in public – but the problem is that the regulators are putting pressure on the banks to get their houses in order to avert another banking crisis.
The result is that the banks are stuck between a rock and a hard place...
The UK Government’s response was to create Project Merlin. A commitment by the leading high street banks to lend to SME’s.
In 2010 these banks lent £179bn of “new lending” to UK companies and for 2011 they have committed to increase this figure by 15% £190bn , of this £76bn is to be made available to SME’s - >£25m.
According to the banks they have lent over £37.3bn by the end of June 2011.
So why the outcry – it comes down to the definition of a “new lend” and whilst I would agree that as any banker in the room will say “they are open for business”, this does not mean that moving an account from either one bank to another is a “new lend” or increasing lending to a business which does not need it is not to my mind a “new lend”.
At the same time company’s are conserving cash and reducing investment, but this does not explain credit policy which has seen successful loan applications fall from a high of 90% in 2007 to a low of 65% in 2010 – this is lending which the banker on the ground is putting forward because they believe in the business – its not equity stuff its real lendable business - and yet credit committees are turning it down.
The real result is a net reduction of £5bn taken away from SME’s in the past year – a year in which the banks agreed, and claim to have achieved, increased lending of 15%!
But why aren’t they lending?
As government’s shout about lending, consumer demands and commercial needs, the impact of BASEL III, the problems in the Euro Zone and a myriad of other “capital adequacy” issues, including the proposed Vickers Report, means that quite simply they don’t have the firepower to lend!
As the rules are written today, in the next 7 years the banks, in Europe – including the UK’s - will need about €1.1 trillion of additional Tier 1 capital (that’s reserves and equity) a further €1.3 trillion of short-term liquidity, and about €2.3 trillion of long term funding, absent any mitigating actions.
That’s a total of €4.7 trillion !
And the impact is pretty awful – increased cost of borrowing, tighter credit decisions, the removal of lending in an already restricted market place and a reduction in annual global growth rates of .01% is what the consultancy group McKinsey reckons.
Against this back drop we carried out a poll on LinkedIn in July of this year. “Are UK Bank’s lending to SME’s?”
We received over 100 responses and 55% answered “No” and 45% answered “Yes”.
So despite what is printed in the press, the poll conducted amongst professionals, financiers and business people was much closer than expected
Interestingly of the 10 bankers, 8 responded (all anonymously) that they weren’t lending!
Comments made on the poll supported the view that banks were increasingly wanting personal guarantees, high fees and low loan to value ratios. However it also highlighted that many businesses are seeking to reduce borrowings as the economic outlook remains uncertain.
This is supported by businesses that I am involved with where the owners are preferring to do this, pay down debt or conserve cash and postponing investment decisions. There is a clearly a high level of concern about taking on more debt at this point in the economic cycle.
Indeed, this is also borne out by the Bank of England’s own findings that “smaller businesses were deleveraging and continuing to repay bank debt” and that “most major UK lenders reported that syndicated lending continued to be driven largely by the refinancing needs of companies rather than for financing new investment projects.”
So as a business person wanting to borrow what are the bank’s looking at?
Robust and well thought out business plans and forecasts – not just the usual P&L, Cash flow, Balance Sheets – but increasingly key performance measures – even down to call and contact sheets for sales people in one instance.
This all leads to tighter monitoring and the banks wanting accelerated timescales for management information – we are seeing the standard request to have MI within 10 days as the norm now, down from 4 weeks a few years ago.
Personal guarantees are virtually “de rigueur” now but not just backed by wealth statements but actual charges over property and assets and almost all the lending is coming with covenants primarily for minimum maintainable net asset levels as well as cash cover and interest cover on earnings.
All the bank’s will state that they are open for business but there is no doubt that whilst the managers on the ground are letting people into the bank – the credit committees have firmly shut the tills!
Now if you can’t borrow money then what how about entering the world of “the masters of the universe” themselves. The world of Venture Capital.
Here we are not discussing Private Equity but rather Venture Capital itself.
The difference between the two is quite distinct.
The private equity investor is looking to for an investment return created more often than not, through the use of some sort of financial engineering. Southern Cross, the failed care homes operator, is a great example of how a P/E house can reap great returns on a business that is left with no intrinsic value. Blackstone’s investment of £162m leveraged large dividends out of the business from the sale and leaseback of properties and eventually resulted in huge returns without much “investment”.
Compare this to a venture capital firm who backs the entrepreneur, investing cash into the company to develop or grow the business, following the money with more as the business grows and risking the investment capital, often even before a proof of concept stage. The US are the big players – Sequoia, Balderton, Silicon Valley Bank, Khosla to name but a few. They will, almost literally, throw millions of dollars to get a business to work.
My problem to be frank is that we don’t have a VC market.
During the period 2008 to 2010 BVCA members invested in 3,000 British businesses with by far the greatest numbers being made as investments into the companies – i.e. New money in.
But between 2008 and 2010 there has been a sharp reduction in the number of companies the BVCA members are investing in – down from over 1,000 in 2008 to under 800 in 2010.
During the same period the amount invested into companies has fallen dramatically, from over £4bn in 2008 to only £2bn in 2010 as the BVCA members moved into the less “risky” are of financing (buy-outs/buy-ins, refinancing, etc) which has seen an increase from £4.2bn to £6.2bn.
So why is it that our “VC” industry is not a VC industry?
It comes down to a simple case of returns.
In order to demonstrate this let us take a moment and compare the state of US Venture Capital, which competes with angels to finance businesses.
Sequoia invested in Google in 1999 as part of a series A funding of $25m – stumping up $12.5m – according to S4 filing documents this investment returned $4.3bn, they also invested in LinkedIn following the initial $4.7m in 2003 with a further $53m in 2008, and retain $1.6bn – and made $0.5bn in a year from $3.5million investment in YouTube.
Meanwhile in the UK, one of our most successful VC’s, DFJ Esprit, itself a consolidator of funds such as Cazenove and 3i.
In 2011 they realised their investment in The Listening Company – a CRM and call centre business – and sold for £55m – giving them a 5x return on their original investment.
Even their muted return on the sale of LoveFilm to Amazon can’t have been huge multiples with a total enterprise value muted to be $300m but Amazon already owned 46% and the rest was split with management, Balderton and DFJ.
In May 2011, EMC carried out a poll on LinkedIn and amongst clients, asking whether or not UK Venture Capitalists were worthy of the title “venture”. The survey highlighted the problem that business owners do not think that our VC’s are worthy of the title Venture Capitalist, with 71% of respondents voting for “no” and only 29% voting “yes”.
Comments made directly to us by business owners, entrepreneurs and advisors demonstrated the strong belief that there are only 10 “true VC’s” investing in risky ventures, but ones that are potentially global businesses. One “VC” went so far as to admit that they were effectively junior debt providers, investing in already profitable (or near profit) businesses which, in the event of failure could be managed out and sold on to repay their investment.
Even one of the partner’s in a leading venture fund described the problem in a letter to me as a response to the survey “everybody from a growth fund, to a VCT, to corporate fund adopts the moniker VC. “
So what are theses ten venture capital firms looking for.
The first is obvious – great management – but what does “offering a compelling value proposition mean”?
Basically they are looking for businesses and solutions that are simple to explain, and which offers an advantage against the current existing alternatives. Being a “me-2” is not good enough.
VC’s all want big markets – not local, and hopefully global, but certainly national.
The last two are pretty obvious “a plan to make money” and they expect to follow the money with more money to get to where you want to be.
As an aside, I mentioned the US competition between VC’s and Angels and I met John Caudwell last year who himself is competing with VC’s – he is investing up to (and probably beyond) £50m into half a dozen businesses which, I am sure, he will expect a number to fail but at least one will go on to make him another £billion!
So if a bank won’t fund and VC’s aren’t VC’s then what options are their for businesses...
We all know about the friends and family route, which almost every successful entrepreneur from the late Anita Roddick of Bodyshop to Mark Zuckerberg of Faccebook can claim to have helped establish their business, but once the business has got beyond those early days, what are some of the alternatives that are “outside the box”...
The first and most obvious ways to fund a business are from within itself.
Stretching the companies working capital helps – but be warned – a recent case made a director liable where he had said that payment was forthcoming and “the cheque was in the post” when it was not.
Hand in hand with working capital management is Investment capital management – I recently went into a business who religiously sold their vans every three years and in recent times have been leasing new ones (having previously hire purchased them). The directors said that after three years the mileage meant that they weren’t worth keeping but then on the way home coming down the M25/M23 I noted the number of large commercial businesses with van’s going back over 6 years old – he was just about to get another 23 vans with a big outlay but we will now be keeping them for another year saving about £11k per month of cash flow!
Despite HMRC’s increasing resolve to not let businesses get behind with their PAYE, VAT or corporation tax payments, asking for a time to pay arrangement remains an option for assisting with funding a business and should be considered as an option in the short term.
And we all know that asset based lending is a great way to unlock cash in a business.
But what other “alternatives” are there to these more traditional methods?
Obviously and old an much used method of funding a business in good or difficult times, but it is still surprising how many times a Directors pension plan with loads of money in it is ignored.
The result can be that it doesn’t achieve its potential or worse still it goes bust.
Meanwhile there is pension pot sitting in the background investing in the stock market or property and even just holding cash. Obviously there are rules and regulations, but they are capable of being overcome with proper advise, it can be a cost effective, quick and cheap way of raising much needed funds.
The internet has brought about some interesting opportunities...
With its history back in the 1990’s when the band Marillion got their US fans to underwrite their entire US tour to today’s dedicated website for entrepreneurs the internet has created a number of portals for entrepreneurs and investors to connect with one another.
In the UK the use of these sites will no doubt be helped by the introduction of an EU directive from 31 July 2011, which now allows companies to issue information memorandums to up to 150 (from 100) people with the intention to raise up to EU5m (up from EU2.5m) without the need to issue a prospectus and go through the hoops and costs of its regulations and controls.
This week the government announced the first distribution of the Regional Growth Fund – “giving out” £950m to 119 companies, but for the South East we ended up with
Portsmouth Naval Base Property Trust
Solent Local Enterprise Partnership
Southampton City Council
The East Kent districts of Canterbury, Dover, Shepway and Thanet
Vestas Technology UK Ltd,
Luton Borough Council
Lotus Cars Ltd
Now I am not sure of all the reasons behind the investments but it would appear that 5 out of 7 of these are public finance initiatives – probably the only ones who can raise the additional £5 for every £1 invested into them that is required to meet the fund’s investment criteria! So the reality of this fund is that it is only available to already bankable and proven businesses.
The Business Growth Fund came out of a working party set up by the British Bankers Association and some of the largest banks in the UK in July 2010 to address the capital gap that exists for SME’s. In October 2010, created and funded by the banks the formation of the BGF was started and it became operational in April 2011.
By November 2011 it had invested in 2 businesses - each investment being about £4.2m.
The investment “criteria” are:
•Target companies that demonstrate a strong growth trajectory and have a turnover between £5m and £100m
•Offer investments of between £2m to £10m in return for a minimum 10% equity stake in the business
•Invest over the long term - five to seven years or more; and
•Consider investment opportunities across all sectors apart from financial services and real estate.
And finally...if you really want to get ahead...
A friend of mine has been trying, unsuccessfully, to have his bank approve a £150,000 loan, despite the relationship manager recommending it.
So fed up with the time taken so far (6 months) to get nowhere, he wrote to Vince Cable and his local MP, quoting back to them all the things that the Government is stating about the fact that banks should be lending, etc, etc.
Within a week, he received a copy of a letter, written to his MP from the boss of the bank. A three line letter, the middle line said simply “the loan has been approved in full”.
When his relationship manager returned from holiday and confirmed that he was still trying to persuade his credit committee to agree to the lend, my friend passed the letter over and asked whether it helped – the funds are currently being drawn down – two weeks later!
So if you really want to get some money to help your business – just write to your local MP and Vince Cable!
