Paths to funding have changed since 2008, but where is it to be found, writes Lyn Calder
Is it possible that on the back of what appears to be a genuine economic recovery that the business community is about to renew its love of bankers? Perhaps, though even the most optimistic banker would most likely shy away from such a rosy assessment after the rocky road they’ve travelled since 2008.
What is clear, however, is that after half a decade of severe criticism of the sector – some of it well founded – there does appear to be a turning of the corner, backed up with increased lending and with better pricing.
Despite this welcome development, it is unlikely we will get back to the good old days of leveraged funding anytime soon. By “leveraged funding” I mean debt being made available for management buyouts (MBOs) and corporate acquisitions which, prior to the slowdown, were commonplace.
In those halcyon days before the banking crisis, these deals were often principally funded by bank debt or, if the price wasn’t quite covered with this alone, with a small sliver of vendor loan alongside management equity.
Of course we all know the landscape changed dramatically around 2008. During the collapse MBOs became scarce, mainly due to the virtual disappearance of debt for these types of transactions. While this has now begun to reappear, the amount banks are willing to put in is less than it was and it is unlikely to return to those heady level.
So while it’s great to see that funding, albeit at a lower level, is once again beginning to emerge some real challenges remain.
Typically, deal funding is now only occurring within companies with at least £1 million of operating profit, ruling out traditional acquisition debt for a large chunk of the SMEs in Scotland.
The good news for smaller businesses seeking an acquisition or MBO and unable to meet the current lending criteria is that several alternatives are available. Asset-based lenders, for example, have spotted the gap in the market but there is a snag in that companies seeking this form of funding need to have recoverable assets to secure debt against. Private equity has always been and remains an option although venture capital appetite for smaller transactions has been curtailed, preferring to focus more on development capital deals at the smaller end where the risk is less with the current owners remaining in place.
The Business Growth Fund, financed by five of the major banks, has also been a means of supporting more leveraged deals. An excellent product introduced at a critical point in the lending crisis, its key focus is on providing development capital, not supporting MBOs. Likewise, the Scottish Loan Fund has provided a debt option but its focus too is on development capital and not succession planning.
Where then do management teams with smaller profits and no debtors, stock or capital equipment go to fund acquisitions or MBOs? Typically to the vendor who is expected to make a much bigger financial contribution than was previously the case, usually at a higher headline price. In a depressed funding market many businesses have had little option but to sell to a competitor, sometimes resulting in foreign ownership which can have negative implications such as a potential downsizing of operations.
Through a combination of greater access to alternative forms of funding and increase in confidence amongst the banks we may eventually get back to the healthy deal funding levels of pre-2008 and, as a result, see a welcome return of MBO activity. Many SMEs and image conscious bankers will be hoping so.
• Lyn Calder is a corporate finance director at Johnston Carmichael