It has been reported in every national newspaper this week, the Bank of England and government ministers have openly questioned, why the banks are not lending the money they have been given.
Simply the money has never made its way to British business, and we are talking about hundreds of millions of pounds. Most business owners have seen this first hand for the last three years. Many businesses need a secure and reliable source of working capital and the banks’ diminished appetite for lending has been an immovable obstacle.
Throughout the financial crisis, the banks have replied indignantly to accusations that they have failed to meet their obligations to lend to businesses, publishing seemingly persuasive figures in their defence. If the banks are to be believed, things should be getting better, but the reality (particularly for small and medium sized businesses) is that things are getting worse – why?
The banks have tightened their risk profiles, increased their charges and are nervous about the money supply falling this year. While banks are keen to publicise the amount they lend to businesses, they are much less keen to publicise how they lend.
Until recently, by far the most common mechanism for working capital funding was the overdraft – very flexible, cost effective and capable of dealing with a wide range of cash flow pressures, from variable debtor days to industry seasonality. Now, unless your business is very low risk or is unlikely to use its existing cash flow cover in full, the chances are that your bank has targeted your overdraft (and your other borrowing) for “review”.
The bank’s objectives will be to reduce risk and increase profits (in both cases theirs, not yours). Even if you have been through the “review” process at your last overdraft renewal, you should probably brace yourself for even more intensive scrutiny at your next renewal. Here are some of the proposals your bank might try to impose (and some tips you might find helpful):
Reducing (or removing) Your Overdraft
Every business should be aware that overdrafts are repayable on demand. The bank can ask for the full amount of overdraft debt to be repaid at any time. The presumption that your overdraft is safe until the next renewal can prove fatal – plan your contingencies accordingly.
Talk to different banks about your business and gauge their enthusiasm for funding it. Obtain alternative quotes. This could put you in a much stronger position when your existing bank calls to discuss your facilities (or at least allow you to deal with their proposals from an informed perspective).
Consider whether alternatives to bank funding are credible. Directors’ loans can be an effective short term fix, but be realistic. Directors loans are nearly always unsecured (your bank will have prior security under its debenture) so be very sure the business will be able to repay.
Increasingly, business owners have been using pension funds to provide working capital. Again, there are pros and cons, but in the right circumstances pension loans can work very well.
If you suspect that your existing facilities are under real threat and you are concerned that alternatives won’t be offered, investigate whether or not your business might be eligible for an Enterprise Finance Guarantee loan (EFG). This scheme was introduced to allow additional bank lending to viable SMEs with insufficient security for normal bank loans. Bear in mind that you will need the support of your bank for approval!
Invoice Discounting
Your bank might suggest invoice discounting as an alternative to all or part of your overdraft. Invoice discounting (and factoring) can be expensive. Service charges, transaction charges and interest can inflate costs dramatically.
Don’t accept invoice discounting unless it is suitable for your business. Invoice discounting can be very effective for debtor cash flow requirements, but might be a very bad choice if used to fund other shortfalls, particularly if turnover is falling or is likely to fall.
Plan ahead and make sure that the bank personnel you deal with really understand your business. Make sure you talk to the right people at the bank – you won’t get an objective perspective from an individual whose primary responsibility is to sell a single type of product.
If you are considering an invoice discount proposal, carefully review the terms and conditions (check for lock-in periods, service charges and interest rates). Consider the impact on your accounts department and review your invoicing and debt collection procedures as these will be checked by the bank.
Personal Guarantees
As a condition to maintaining your overdraft, your bank may ask for new or increased personal guarantees from the directors. Personal guarantees should only be given after very careful consideration and never without proper advice from a solicitor.
If you give a personal guarantee to support a company that you are a director of or own shares in, the chances of avoiding liability under the guarantee are extremely small, even if you didn’t get legal advice when you signed the guarantee.
Many directors decide they are sufficiently experienced and competent to understand exactly what they are getting themselves into. In most cases their decision demonstrates that they are not. On the face of the guarantee document itself, it can appear that the guarantee relates to the specific loan or extension for which it was a condition. This is hardly ever the case. Personal guarantees usually cover all company debts, current and future and this is often a very nasty surprise for the guarantor.
Liability limits are another source of confusion. Limits are always exclusive of interest and costs, which include the banks legal costs in enforcing the guarantee. The bank won’t necessarily skimp on legal costs!
Ending Unprofitable Term Loans
Some businesses still benefit from long term bank loans, with “over base” rates calculated on much higher base rates than are currently in force. Banks hate these loans and in many cases will go to considerable lengths to end them.
The bank will need to have good reason to end any term loan – they are not repayable on demand like an overdraft. The bank will need to show that the business in question has breached the terms of the loan. Many loans include lengthy and complicated covenants relating to the company’s financial performance and the ways it is reported to the bank, so there’s much more potential to commit a breach of the loan agreement than a simple late payment.
However, in most cases the bank will have to serve a formal Default Notice giving you a period of time to put things right (usually at least 7 days). Do not ignore a Default Notice – act on it immediately. If in doubt, get advice.
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