As managing director of a brokerage raising funding for SMEs I am often involved in sourcing funding for proposed acquisitions. I also see the situation from the other side of the fence, as I am also a director of an acquisitive SME in the manufacturing sector.
Whichever side of the fence you’re on, raising equity is a difficult and uncertain process. That’s not to say that it is impossible, but it does involve a need for a very active search to find institutional or private investors whose criteria for funding the project, team and return match yours.
An obvious result of this difficulty in obtaining equity is that the ability to raise debt becomes more important, as the more debt the buyer can squeeze out of the available asset base, the smaller the requirement for equity becomes.
Asset-based finance as a source of funding is well established, but as a result of last year’s retreat from excess liquidity in the markets, we are seeing a returning realism in respect of achievable rates and advance levels from advisors, while lenders are subjecting transactions to greater scrutiny.
Mix and match
The movement of factoring and invoice discounting firms to become asset-based lenders offering structured packages of funding across all the core security assets is continuing, but it remains the case that mixing and matching loans from specialists in each asset class will usually result in a better overall package.
There may be niche products which can be of importance in a deal as, for example, while most plant and machinery funders discount large installed production lines and infrastructure due to the difficulty in realising these as security, there are funders who specialise in this area that can take a radically different view.
If this is a case for ‘hard assets’ where security values are normally well understood, what then about things such as cashflow and contracts?
It has always been the case that for the right situation and customer the commercial banks have been willing to advance cashflow loans. For example, one bank’s current policy is to advance up to three times EBITDA on this basis, depending on the size of the deal and the stability of the target’s earnings.
Access to this type of funding may become increasingly important if there is a downturn in the economy, as strong businesses will want to go shopping for bargains. They may, however, be held back by the inflexibility of bank finance, which tends to require details of the specific target for which the funds are to be used.
Having moved to become all-asset funders, many of the asset-based lenders are now taking the next logical step to differentiate themselves from their competitors and adding cashflow loans to their product offering. This might typically mean an additional advance of, say, 50% of the debtor book, repayable over a three-year term. My concern with these arrangements, however, is how the lender will manage situations where borrowers start to get into difficulties, and I could see some of these ending in tears.
Some asset-based lenders have also become Small Firms Loan Guarantee scheme lenders, which can enable them to provide higher levels of advance.
Contract funding
But it is in the field of contract funding that most innovation is currently underway with a number of trade finance houses able to provide a range of solutions, including the funding of CIS construction contracts, while funding advances of up to £1m are available for situations with a demonstrable income stream from long-term contracts.
In addition there are some approaches, which do not rely on the available
security.
In any acquisition, the seller is an obvious source of funding by way of
deferred consideration, but tends to be reluctant to accept this approach due,
in part, to the risk that they may then never see their money. This issue can be
mitigated because it is possible to arrange bonding of this deferred element
backed by highly credit-rated institutional funds.
A small number of funders now offer an unsecured product that can be used to fund up to two months gross payroll on a rolling basis. As you would expect, this approach tends to be available only to strong borrowers and comes with a reasonably high price tag.
As the provision of SME lending products continues to develop, increasing numbers of niche products and lenders are emerging to augment traditional lending based solely on normal debenture formulas and ‘hard security’ assets. Where the deal is right, this can help to reduce the reliance on finding equity to support a transaction.
Running a risk
The growing complexity of the lending market presents real opportunities for firms to act as advisers also presents risks as it is a market with a large numbers of players offering a constantly developing range of products and operating to a variety of criteria.
Meanwhile, the client needs to obtain the funding package that is the best match for their particular deal’s requirements on the best terms available from a lender whose criteria they match.
The danger for advisers is in providing ad hoc advice, either explicitly in providing a recommendation, or implicitly in the suggestion or selection of an appropriate shortlist of lenders.
What to look for
Managing partners should be asking themselves these questions:
• Does your firm have a clear process for tracking the lending market and do you have the appropriate market knowledge to offer clients advice in this area?
• How do you ensure that clients are offered advice in a consistent way across the firm?
• Do you set out the basis on which advice is given by way of a letter of engagement specifically covering this work?
• Is there an audit trail that can be used to demonstrate on what basis the advice was given? If you cannot demonstrate a process to ensure that you are providing your clients with the best advice then you may unwittingly be running major reputational and litigation risks.
• Consider entering into partnerships or strategic alliances with specialist brokers. This way these firms can ensure clients are properly advised about their choices in respect of mainstream funding lines in a traceable and auditable way, while ensuring they have knowledge of, and access to, the full range of products.
Mark Blayney is MD of finance brokers Creative Business Finance Ltd
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