SMEs and the credit crunch

With the current turmoil in the banking market triggered by sub-prime lending in the US, banks will be looking to recover their margins from small businesses. But what do banks mean by the small business market?

We have seen a steady reluctance by banking institutions to operate business criteria for small businesses. It might be that bankers’ definitions of small business are different to many accountants. Recently, I approached a bank for a client ­ a limited company that was profitable, expanding and with credit balances that was looking for a better internet banking facility. The answer I was given was: we are really only interested in businesses doing more than £1m turnover with a borrowing requirement of £250,000 or more.

Part of the reasoning was that the bank did not want to take on a ‘small’ account as that might overload its high service standards to business customers. But this was a customer who didn’t want that level of service. The company was looking for a good internet facility so it could effectively manage its own account.

Borrowing risks

The real problem, however, comes with businesses that need to borrow money. If the small business is a sole trader or partnership, the proprietors understand the personal risk involved with borrowings.

But limited liability is something banks do not believe in. There used to be a time when banks would usually match money put in by business owners on an unsecured or, at least, a debenture basis, when invoice finance was secured solely on the underlying book debts. Banks would ask for an amount of personal guarantee, but would only ask for that to be secured in extreme circumstances.

Now, the first question is: ‘What security can you give?’ They don’t mean security in the business, unless it is an unencumbered property ­ preferably your house, on which they can take a mortgage charge.

This approach is hardly helpful, particularly if your customers only need a temporary facility because a contract has over-run and the payment from your customer is going to be a week late, meanwhile you have VAT and wages to pay. Many banks are even reluctant to take out debentures on a company once they’ve got their supported guarantee, even though it might be offering protection to the director or shareholder.

With bank managers now considering small business funding essentially as if it were personal secured lending, it is important that owner managers look closely at how they raise funds to protect themselves against unnecessary personal exposure. While business will always involve a degree of personal risk, there is scope to limit exposure by examining finances closely.

Small businesses must look at how they structure and secure borrowings to the extent that business bankers may simply be providing clearing services, with the account operating in credit at all times.

It is vital to look at all forms of financing to ensure that any available security within the business is utilised. Always use your own money last, as that is the easiest to get hold of for a short-term crisis. Think of any extra interest charge as an insurance premium to keep money available should it be needed.

Guaranteed loans

• If the bank insists on security, then it may be better for you to negotiate funds privately and lend them to the business itself.

• If you are buying capital assets, look to finance that with hire purchase or leasing, so the security is against the asset itself.

• Consider invoice finance, as this can be arranged with security simply limited to the invoice values. These kinds of borrowings can attract very competitive interest rates and arrangement fees are often cheaper.

• Credit cards can be put to good use for short-term facilities. Interest rates here may be high, but for the amounts involved this can be offset by the lack of arrangement fee.

• Look at the Small Firms Loan Guarantee scheme available for new businesses. If clients do lend money to their business, they should take out a debenture as security, or if they secure business borrowings with a personal guarantee, they should insist that the bank does so.

Jonathan Russell is senior partner at ReesRussell and president of the UK200 Group

For more information go to:
www.businesslink.gov.uk
www.berr.gov.uk
www.reesrussell.co.uk