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Financing your business: Can owner-managed businesses access funding in today’s climate?

26 October 2010

Paul Connell, partner at commercial and asset finance providers First Financial, a division of FRP Advisory LLP, discusses the various options available to businesses:

If you have owner-managed business (OMB) clients, you would be forgiven for thinking that there is an ever decreasing number of financing options available and, even if you find an open door, the acceptance criteria are becoming more and more onerous. Largely, you would be right in these assumptions; however, in our view, there is a danger of this becoming a self-fulfilling prophecy.

Bank of England research shows that there is around £25billion of new lending to business quarter on quarter (British Bankers Association (BBA), September 2010) – and this would reflect the assertions from the main high street banks, both state and non-state funded, that they are open for business. According to the BBA, new lending is being masked by businesses paying down debt, and the high street banks say there is simply a lack of demand.

In reality, the situation is slightly more complex. Certainly the demand for new finance has fallen - only a minority of OMBs are undergoing the type of rapid expansion that requires significant growth funding - but the need for refinance is very much on the agenda. According to the Government’s latest report, Financing a Private Sector Recovery (July 2010), the level of refinancing by businesses is expected to peak in the next three years, which reflects the large amount of 5 year debt issued in 2007 and 3 year debt issued in 2009. In our experience, it is those OMBs seeking to refinance, that are facing the biggest barriers.

The majority of OMBs still try to rely on bank funding, usually in the form of loans or overdrafts, to sustain working capital or for capital expenditure activity. However, following the credit crisis, the banks’ criteria for refinance have become increasingly stringent. This was a natural, and most would argue correct, response following the over-supply of cheap debt and exposed balance sheets during the recession. But, nevertheless, the reality is that most OMBs will have to work hard to justify a refinance deal, and very few will be able to secure any additional funding.

So what are the options?

Well, firstly it is important to say that the banks are open for business. Yes, the business case must be strong, there must be robust projections demonstrating the ability to service debt, but they are by no means a closed shop. The challenge for many OMBs is to provide the level of security and evidence of future viability which can make bank funding inaccessible.

Traditionally, in recognition of OMBs lack of access to external sources of finance open to larger companies (equity markets, flotation, bond markets), the Government has sought to close the equity gap with state provided finance. The new Coalition Government extended the Enterprise Finance Guarantee scheme to 31 March 2011, announcing an additional £200m in funding in the June Budget. Two other funds were also launched at this time targeted at OMBs: the Enterprise Capital Fund – £37.5m in funding available to innovative small businesses with high growth potential; and the Growth Capital Fund – aimed at established small and medium-sized businesses (SMEs) to address gaps in the market provision of growth capital.

How appropriate these methods of funding are and, crucially, how accessible they are, will depend very much upon the nature of the business and in which sector it operates. There is a strong appetite to fund businesses operating in growth sectors, environmental technologies or medical science for example, but weaker demand to work with more traditional companies in already mature markets.

Of the two sources of finance, Government funds and bank lending, bank lending remains the most popular choice. Despite net bank lending falling since 2008, it still accounts for the majority of an OMB’s liabilities. What is most surprising is that so many businesses only choose to access traditional forms of bank lending. Of the 4.8m businesses in the UK that make up the SME sector, only approximately 20% use asset-backed or asset-based finance. It could be, as the findings of the Government report suggests, that the reason for this is that too few businesses seek advice when looking at financing options and so are unaware of the choices available to them.
Asset finance, whether leasing or hire purchase, invoice finance (via factoring and invoice discounting), or stock financing, offers OMBs an opportunity to proactively utilise the full asset mix to secure finance. This type of finance, which alleviates cashflow pressures and allows for expansion, is also a sensible funding method during an economic recovery. It enables business to be more flexible, grabbing opportunity, reducing fear of the potential consequences of over-trading.

Given the restricted availability of other methods of funding, and the appetite of the asset finance community to do business, we would have expected to see a higher demand for this type of finance. However, a lack of awareness and a false perception that asset finance is a facility of “last resort,” has dampened demand.

There are undoubtedly sources of finance available to OMBs, whether refinancing or funding for growth, and to suggest otherwise is simply wrong. If this opinion becomes anymore widely held it will lead more OMBs to shy away from making any approach for finance, the consequences of which would be disastrous. But it is crucial that the right advice is sought. The finance option must suit the business model and its market, and the approach must be well-considered and tailored. It is well-worth talking to experts such as First Financial, that operate in this field every day, because the days of hawking a business around potential funders until one of them says yes are long gone.

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To find out more about how First Financial can help you and your business, visit the website at www.firstfinancialuk.com or complete and submit the online form below.

If you would like to discuss any of the topics raised in this ebrief, or suggest a topic for a future ebrief, please do not hesitate to contact a member of your local FRP Advisory team.