Companies faced with a lack of credit over the next 18 months need to keep their heads and find creative ways to survive.
When the sky is blue and the sun is blazing, it is hard to imagine ever feeling cold again. And when the trees are bare, sleet is falling and the weather is grim, summer seems a distant memory.
Whatever the external environment, the climate for most companies is very bleak indeed. The carefree days of the mid-noughties, when business was booming and cash was plentiful, seem a long way away. Profligate banks have come down to earth with a bang. Now they are either at the mercy of the Government or demanding shareholders. They are under pressure to rebuild their balance sheets – by lending less and charging more.
To many innocent victims of this credit squeeze, the banks’ behaviour seems at best unfair, at worst malevolent. But for companies in need of cash, moaning about the situation won’t help. Managers need to be creative and find alternative ways of survival. This is not easy.
“Businesses of all shapes and quality are facing a terrible squeeze on cash. The problem is that everything has happened at once. Trading is under pressure, banks are withdrawing credit, and many lenders, most obviously the Icelandic banks, are leaving the country,” says Rob Donaldson, Head of M&A and Private Equity at Baker Tilly.
“Even in good times, there are four basic ways of raising money: go to a bank; use the public markets; use private equity; or dispose of non-core assets. All of these are less attractive than they used to be,” he adds.
Comforting noises
In other words, the situation is tough, as every business looking for credit knows only too well. But it is not impossible. There are ways of surviving the credit crunch, and those businesses that do so will almost certainly emerge stronger and fitter than ever before.
The first, and most obvious advice, is to stay calm. It is easy to become panicked when the economy is nosediving, profits are falling and banks are running scared. But taking stock and creating a strategic plan of action can be helpful for the owners of a business and their employees. It can also be reassuring for bank lenders.
“Businesses need to plan much further ahead. If they have bank facilities coming up for renewal, for instance, they should start thinking about how these will be refinanced six to 12 months ahead of time. They should talk not just to their existing lenders but to others as well,” says Donaldson.
“This is particularly important as some credit teams are paralysed. They are unsure of what is happening further up the chain of command so they can make comforting noises initially and ultimately have to say no. In other words, you cannot rely on warm words from your relationship manager,” he adds.
Talking to a range of banks can be helpful in more ways than one. Many banks are reluctant to take responsibility for an entire facility, but they may feel happier sharing the load.
“Club deals are increasingly common where two or three banks come together and share a transaction,” says Donaldson.
Enterprising business managers bring banks together themselves, rather than waiting for the banks to find each other. And some banks are more open to deals than others.
“The Scandinavian banks are in better shape than many Europeans, and the UK banks may begin to soften up, following concerted government action to make them lend more to small and medium sized businesses,” says Donaldson.
Many businesses have already found it helpful to change banks and use new lenders. “Some banks do still have money to lend. We did several deals last year and got bank debt on all of them. The situation changes from month to month but some banks will do business with the right customers, and some want to exit certain areas but get more involved in others,” says Richard Chapman, Director at mid-market private equity firm ECI Partners.
There are other borrowing options as well. Certain private equity firms are now offering debt finance not just to firms within their portfolio but to external companies as well.
Open for business
"We raised a £50 million debt-focused fund last autumn and we are now offering a ‘breathing space’ product that companies can use to refinance an overdraft or make acquisitions and that private equity firms can use if they need debt finance,” says Andrew Cavaghan, Director at investment company Octopus Investments.
The Octopus product is more flexible than most bank loans. “It is a five-year non-amortising loan with nil capital repayments till maturity. We charge a margin over Libor in the early years, and the terms are similar to those on offer from a bank. Borrowers can repay after two years but if they choose to continue, the facility incurs an increasing interest rate similar to mezzanine finance. Clearly, the precise terms are dependent on the business and the quality of its earnings,” says Cavaghan.
The ‘breathing space’ product offers businesses up to £4 million and the average amount taken so far varies between £1.5 million and £3 million. Demand has been strong, and Octopus is aiming to raise a further £25 million for the underlying fund.
“We are much more flexible than most banks. If a company is doing well and wants to repay the debt, that’s fine. If they are not doing so well, we can adjust the return to reflect the risk. There is less confrontation involved,” explains Cavaghan.
Mezzanine-type finance is part of the Octopus product, and it is also available from other lenders, in various guises.
“Mezzanine finance is on offer from specialist funds and niche lenders. It is more expensive than straightforward loans, but it is out there. It also tends not to involve any ongoing capital repayment,” explains Chapman.
Private equity is an option in itself for companies in search of cash. “Private equity firms will do a deal without bank debt if the transaction looks suitable. There may be a chance of bank debt materialising in the future, or a company’s growth prospects may be sufficiently attractive to do a deal without any recourse to bank funding,” says Chapman. “It is also possible for private equity firms to take a minority stake without bank debt.”
Private equity firms are as cautious as any investor in the current climate but they are certainly open for business and some are specifically focused on helping companies in trouble.
“Private equity firms still have a fair amount of cash, and they are willing to invest in the right opportunities. If a business thinks they have funding needs coming up in the next two years, it is worth building up relationships with private equity firms now,” says Donaldson.
“And some funds are looking at distressed situations in particular,” he adds. Private equity may seem a radical option to some businesses as firms tend to take a seat on the board and become involved in companies’ planning and direction. But the rewards can be generous and private equity can provide valuable support.
“There are plenty of examples of companies turning down offers and then regretting it. Of course, prices are lower than they were, but they may go lower still,” says Donaldson.
One funding option that is gaining traction among certain businesses is asset-based lending. “Invoice discounting, and asset-based lending generally, can be an interesting way of raising capital.
It is a lower-risk option for a bank because it is asset-backed, and for some companies, such as recruitment businesses with lots of contract workers, it is ideal,” says Chapman.