Funding is a crucial issue for smaller businesses – in many ways more important than for larger companies which hold greater sway over lenders. It was a point made best in a report published earlier this year by Dun & Bradstreet. According to the credit-rating agency, smaller businesses are going to the wall twice as fast as the big boys.
The strong pound, weak export markets and a none-too-attractive domestic situation, where many customers are still bearing the scars of the last recession, have combined to exacerbate the problem. And in the eyes of many within the business community the government is doing more to hinder than to help. The reality of Gordon Brown’s Budget boast that he would boost UK entrepreneurship – ‘we will champion the needs of small business; we will cut taxes on enterprise,’ he told the Commons in March – has been questioned by tax practitioners and businessmen and women alike.
All of this adds up to a far from ideal situation for small and medium sized businesses. But it is the reality that they have to deal with.
When it comes to finding funding, smaller businesses are not spoiled for choice. Despite successive cuts in interest rates, bank funding is expensive and for many businesses it is inaccessible.
Listing is often not an option. Joining the London Stock Exchange is a costly and often unsatisfying business. A 1997 survey found the average cost of bringing a company to the market to raise £5m was approximately £362,500, according to the London Stock Exchange.
Meanwhile 87% of companies listed on London’s Alternative Investment Market told Mazars Neville Russell earlier this year there was not enough liquidity in the market, and 56% said their broker did not provide a good enough service to encourage trade in their shares.
Increasingly SMEs are turning to less typical funding sources. Among the growing areas is trade finance. Unlike invoice discounting or factoring, trade finance is about funding the front end of the business, the buying of the product that will be sold on. When companies are unable to access capital from a bank, they will often turn to a trade finance house.
‘Banks are low-margin, low-risk lenders,’ says Steve Marsh, business development director of Davenham Trade Finance . ‘They are only going to do any kind of lending for SMEs if they have got acceptable collateral.’
Trade finance companies like Davenham and Versailles Trade Finance are among a dozen or so such businesses.
In effect a trade finance company will buy plant or other goods on behalf of a company which is unable to get more conventional funding.
It works most effectively for small and medium-sized companies which are looking to borrow quickly and efficiently in a way that is unlikely to attract much interest from banks. Typically they are looking to import materials and finance orders.
‘The system works best because transaction financiers look at the underlying nature of the transaction and understand the components of the cycle as they take place on a day-to-day basis,’ says Versailles Trade Finance marketing manager Nanda Khiara. ‘Traditional lenders provide cash or credit and only do so when a client meets a raft of conditions such as minimum fees, debentures, guarantees and securities.’
The manufacturers which supply the goods invoice the trade finance house and receive an agreed percentage – usually 80% – upon those goods being delivered and accepted by the customer. Once the trade finance house has invoiced its client and received the cash, the remaining 20% is released to the manufacturer.
It differs from factoring or invoice discounting in the sense that trade finance is funding the front end of the transaction and is a pay-as-you-go system that does not commit the client to a minimum contract term.
Invoice discounters are often interested in a spread of debtors to minimise risk, whereas trade financiers are only interested in the one transaction.
‘A lot of our deals are 30 to 60 days and clients may only use us once,’ Marsh points out.
Over the last four to five years Davenham Trade Finance has lent around £150m to companies at an average loan size of £250,000. Davenham usually lends to customers that deal in lumps of metal: printing presses, packaging material, excavation equipment and engineering machinery.
But it also extends to clothing manufacturers, producers of seasonal products like fireworks and Christmas gifts and electrical goods. Final customers tend to be recognisable names – ‘high-street retailers, mail-order companies and DIY sheds,’ says Marsh.
Most trade financiers want to see margins of at least 30% on any deal they get involved in. The risk of being left holding the baby also means funders are not usually interested in products like perishable foods, arms or chemicals in bulk.
If the flexibility of this system sounds like it should come at a price, it does. The service does not come cheap: interest is usually 2% a month.
Marsh makes no apologies. ‘It is expensive but if we are charging £4,000 and you are making £46,000, without us you are not going to be able to do it,’ he says. Costs can be minimised, however, depending on the length of the loan. ‘The shorter the cycle the lower the charges,’ says Khiara.
Trade finance is not something usually offered by accountancy firms’ corporate-finance teams. ‘I think people get involved in trade finance for very specific activities,’ says a corporate-finance specialist at one top 20 firm.
A smaller business turning to these advisers is likely to hear a different story. At this level, venture-capital funding is popular and bank loans and overdrafts are more likely recommendations. Ask about transaction-based finance and you are more like to hear about factoring than trade finance. ‘SMEs can also develop leasing arrangements for their fixed assets while securitisation is also possible,’ says Baker Tilly corporate-finance partner Tony Pierre.
Tim Berg, also a corporate-finance partner with the firm, points to off-exchange share listings as a good way of capital raising. ‘It has been very successful because companies can raise finance without being under the strict regulations of the Stock Exchange as they would if they were to go for full listing.’
But these are tried and tested routes. Each has its own advantages and disadvantages. Venture capitalists dilute equity, banks demand security and share placements are expensive.
There are new products coming on to the market all the time, however. A new service launched by Cavendish Management Resources is interest-free loans for growing companies. CMR has spent 12 months developing the product which, managing director Mike Downey says will ‘revolutionalise’ the sector.
It’s a fairly simple procedure. Cavendish Management Finance Corporation – a CMR subsidiary – buys products in bulk and sells them on to its customer companies.
CMFC is able to make cost savings of 10% to 15% by buying in bulk, and these cost savings are used to pay interest and other procurement charges and pay off some of the initial capital.
Downey says that because of the cost savings against the normal purchasing costs of smaller companies, loans can be repaid more quickly. Once they are repaid, the company will benefit from the ongoing cost savings.
‘A company with a turnover of £5m per annum is likely to have a purchase cost base of around £2.5m, and in normal circumstances, this will produce cost savings of around £250,000 per annum,’ explains Downey.
But there are some restrictions. The minimum loan level is £100,000 and Downey says that the company is only interested in clients with a turnover of between £4m and £50m a year.
Any smaller than that and it might not be worthwhile for CMR to provide the service; any bigger and the company is already likely to be making considerable cost savings.
‘I think that this will become the predominant form of funding because banks get a greater level of security than through a normal form of funding,’ boasts Downey.
‘The only losers the are suppliers who get displaced because they have been charging too much in the past. Everybody else wins.’
FINDING THE RIGHT BACKING
Trade finance Pros: About a dozen or so trade finance companies provide working capital for growing companies to fund purchases and finance credit periods given to customers.
Cons: It may be flexible but it is expensive: typical loan charge is 2% a month.
Alternative Investment Market Pros: It is designed for younger, growing companies Once a company and its advisers have decided to go ahead, it generally takes three to four months to come to the market which can be an important source of funds.
Cons: Some companies spend up to two years preparing their business for admission. Liquidity is often a problem – most institutions are not really interested at this market level – and it can be costly. See also www.stockex.co.uk/markets
Venture-capital funds Pros: Offered by several companies and soon by the government on a regional basis with funding of up to £500,000 available to individual businesses.
Cons: Venture capitalists lend money so they have a stake in the company’s future success. They dilute your equity. See also www.dti.gov.uk/sbs
Interest-free loans Pros: Loans of £100,000 and above are available from Cavendish Management Resources for companies with an annual turnover of between £4m and £50m.
Cons: not yet widely available and not applicable to certain companies and certain sectors. See also www.cmruk.com.
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