We see it in terms of a relationship rather than a deal,” says Simon Harris, CEO of Metropolis AV and FX, a supplier of lighting and audio equipment to the entertainment and hospitality industries.
The company – which counts theme parks, nightclubs, pubs and fitness centres among its clients – has recently secured a package of restructuring finance to enable it to invest in the relatively new technology of LED lighting, currently one of the hot buttons of the electronics sector. Agreed with HSBC, the package includes three main elements: invoice discounting, asset finance to take out cost and a longterm loan to provide cash.
According to Harris, the company was not necessarily sold on the idea of bank finance before it began discussions with HSBC. But it quickly became apparent that the bank had experts on hand who could not only draw up a comprehensive finance package, but also took an informed interest in the business itself and the market it was seeking to address.
It wasn’t only the market that was assessed by the lender. With the cash element of the package coming in the form of an unsecured loan, the bank was at pains to assure itself that it was backing a viable business. That meant the quality of the company’s management came under scrutiny, as did its trading record. Harris believes this third party involvement with the company did have a positive effect, including hiring a new director to plug a gap identified by the bank.
Harris describes the due diligence process undertaken by the bank as “arm’s length”, when compared to the hurdles his company might have been required to jump had it gone to a VC. The Metropolis experience, he says, illustrates that anyone seeking a significant amount of bank finance should be prepared to see the lender take a long hard look at all aspects of the company before putting cash on the table.
And this isn’t simply a case of risk assessment. As business lending becomes more sophisticated, banks are increasingly offering so-called ‘structured finance’. This brings together several types of loan or credit arrangements in a single package bespoke to the circumstances of the individual company.
So instead of a single loan to cover the cost of expansion, the bank might offer you a number of loans repayable over different timescales (depending on whether you need working capital, cash for a specific project or finance for an acquisition), plus an invoice discounting facility to help with cashflow and leasing or HP deals to keep costs down at a crucial time.
In the current climate of relatively low interest rates, this kind of finance is cheap and doesn’t dilute the equity of existing shareholders. However, lenders need to assure themselves they really understand the businesses in question.
You can expect a lender to look carefully at your business plan and, depending on the size and complexity of the deal, your friendly neighbourhood business banker may also take an active interest in whether or not you have the right mix of management skills to meet your objectives. And as Andrew Gent, head of corporate banking at Singer & Friedlander, is quick to stress, the bank will not only look at the quality of the directors but also indicators of commitment? “We like to see that they have put money into the business – or that they have something to lose, whether it is cash or reputation.”
CASH IS KING
Of course, the other way of ensuring owners have something to lose is to insist on security. But as Martin Allison, regional managing director for commercial banking in London at the Royal Bank of Scotland, points out, business bankers do not tend to lend simply because a company or an individual can put up personal or commercial assets to guarantee the bank’s money. “What really counts is cashflow and the ability to make repayments,” he says.
Kevin Gillett, head of the Bank of Scotland Business Banking Unit, agrees. “Security is relevant but it isn’t the reason to lend. The main factor is the viability of the business. If we were lending simply on the basis of security, we would be little better than pawnbrokers. That’s an approach I don’t agree with.”
However, while banks consider the recovery of assets after a business failure to be a time-consuming and costly headache, they do tend to prefer situations where the borrower can offer some sort of security as a last line of defence.
That doesn’t mean you’ll have to put your house on the line as lenders will consider less tangible assets such as intellectual property rights or debtors. Indeed, as Britain’s economy veers inexorably away from manufacturing businesses towards services, lenders have little choice but to look to assets other than property.
And if you can provide evidence of a trading record with consistent, or better still, growing cashflow, you may be able to avoid the requirement to put up security in the conventional sense. “It might be that a business has sustained cashflow of £1m per annum,” says Martin Allison. “Credit could be extended on the basis of that cashflow.”
The caveat here is that the quality of security (or the lack of it) will have an impact on repayment terms. As Rob Donaldson, head of M&A at accountancy firm Baker Tilly, explains: “A loan based on property could be anything up to 15 years. For an unsecured loan you could be looking at a maximum of five years.” This reflects the ongoing value of the asset. For instance, if your loan is secured against property the chances are it will retain its value over a protracted period of time. If on the other hand, your security is intellectual property or cashflow, the value could fall rapidly. Repayment periods tend to reflect those factors.
That isn’t necessarily a problem, of course. According to Gillett the average repayment period for both unsecured and secured loans is three years, with banks prepared to lend over much longer periods. The truth is most people want to clear their debts as quickly as is humanly possible.
CHANGING TIMES
All well and good, but what if your business requirements change and you need to extend the loan period? The good news is banks are more than happy to provide additional finance when the need arises. Indeed the chances are they’ll use a commitment to the ongoing support of your business as a selling point for your service.
Let’s take an example. Say a bank has advanced a loan to your company on the basis of your intellectual property. In a worst case scenario, developments in the marketplace could wipe out the value of this asset at a stroke, and you would probably find it difficult to get a bank to lend on the same terms again.
However, a sustained R&D effort could supply you with an even more valuable array of IP assets while at the same time presenting you with a shortfall in the cash needed to take your products to market. In these circumstances, you could reasonably expect your bank to provide further support to take the business forward. This could take the form of additional funding or payment holidays.
But it’s important not to take the lender’s largesse for granted. They expect to be fully briefed on developments. “We want to see this as a partnership,” says Robin Fanner, regional director of corporate banking at Lloyds TSB, echoing the words of Harris. “We want to buy into the strategy and will expect to receive full information.”
HOW MUCH CAN YOU BORROW?
The terms of business bank loans are typically worked out on a case-by-case basis, with the amount on offer dependent not only on your requirement but also on the circumstances of the company. If borrowing against cashflow, you might find it relatively easy to agree on a multiple of 2.0 with any increase on that dependent on some pretty comprehensive due diligence. Alternatively you could negotiate a loan based on a percentage of your property assets.
It’s worth pointing out here that not all banks are the same. Some have particular expertise in certain sectors or business strategies such as acquisitions or MBOs. And their understanding of your needs will colour their willingness to lend.
Even within the hallowed halls of a particular lender, you can save time by ensuring you’re speaking to the right person. For instance, Bank of Scotland Business Banking tends to deal with businesses turning over up to £1m and seeking to borrow in the region of £100,000 and you shouldn’t expect to access ‘structured finance’ deals at this level.
WHAT ARE THE COSTS?
Just as banks tend to lend on the basis of the perceived viability of the business in question, the cost of the loan is directly related to their assessment of the risk. As a rule of thumb – although this does not always apply – an unsecured loan will be more expensive than one that is secured by assets.
Equally, the bank could fix its interest rate level on the basis of the perceived risk of a particular strategy, such as an acquisition or the business’ track record. Lloyds TSB’s Robin Fanner says the variation can be considerable. “In the case of senior debt (a standard loan repayable over a fixed term) we have gone as low as 1% above base,” he says. “In the case of riskier mezzanine finance it could be in the range of 4% to 5%.”
Most commentators are agreed the climate for borrowing is good at the moment. Interest rates are still relatively low and banks are doing their best to respond to the demands of Britain’s ever-more entrepreneurial economy by supporting a comprehensive portfolio of debt products. But to access these, you could find yourself having to ‘pitch’ your business almost as you would to a VC. Over to you.
