Love them or loathe them, banks are here to stay. Even with a multitude of other financing options available, from floating on AIM to asset-based lending, a bank loan is still the preferred option for thousands of businesses looking to expand or make an acquisition.
Take Carlton Bingo, an operator of bingo clubs in Scotland and north-east England. The company was bought out by its management, backed by private equity firm Dunedin and debt from Bank of Scotland. Five years later, the management bought out the private equity interest courtesy of another loan, this time from Lloyds TSB.
‘Bank of Scotland was the holding bank, but there were a number of other banks interested in the deal,’ explains Carlton Bingo’s MD, Peter Perrins. ‘Lloyds TSB came in with a very attractive offer, which enabled us to do the deal to our advantage.’
Two years passed, and Carlton’s management went back to the bank again. They planned to augment their property portfolio of former dance halls and cinemas with two purpose-built, flat-floor bingo clubs, requiring a total investment of £14 million. Again, Lloyds TSB stumped up the cash.
‘In terms of our development plan, we’d delivered what we said we’d deliver, so our credibility was good at the point of lending,’ says Perrins. ‘It’s an ongoing relationship you try to build up with your bank: you’re in it for the long term, and the banks are interested in good long-term relationships too.’
It’s a point echoed by Alexander Baldock, commercial director at Barclays. ‘The bank wants lasting relationships with customers, not just because we’re nice guys, but because it’s more profitable,’ he says. ‘It’s not in our interest for customers to over-extend themselves.’
Choosing the right bank for your business
Choosing the right bank can be difficult when the offerings for business look so similar. Suzi Woolfson, partner at professional services firm PricewaterhouseCoopers, always advises her clients to begin with their current bank. ‘For me, it’s all about relationships,’ she says. ‘Hopefully, you’ll already have one with your existing bank. If not, find another bank with an understanding of the industry or business you’re in – then choose the person you’re most comfortable dealing with.’ Woolfson advocates approaching two or three banks to ensure you’re getting the best deal, while bearing in mind that cheapest doesn’t always mean best.
‘Most clients say that price is important, but you need to make sure the bank can deliver on the price,’ she adds. ‘I have seen times when the person my client was dealing with didn’t go to the bank’s credit committee before making the initial loan offer, and it was subsequently pulled.’
Woolfson adds that it’s important to understand exactly who you’re speaking to: is he or she the person who will approach the bank’s credit committee, or are you several stages away from the decision-maker?
David Richardson, regional MD at Lloyds TSB, observes that transparency should be high on any bank’s agenda: ‘You don’t want to be given ten requirements and then, when those are satisfied, be presented with another ten.’
Of course, the whole process will be expedited if the business seeking the loan has done its homework before meeting the bank. Woolfson stresses the importance of presenting a persuasive case backed up with all the right figures.
‘You need to have a solid business model,’ she states. ‘Don’t go with just an idea. You’ll need solid cash flow figures – a strong balance sheet with clear profit and loss figures. You have to show that you can service the debt. Of course, they might challenge your assumptions, but your proposal needs to be robust.’
Eric Gunn, divisional director at Clydesdale and Yorkshire banks, notes that preparation will stand you in good stead: ‘We’re looking for the person behind the business to come to us and paint a clear picture of what they’re trying to achieve. We look at the management team as well because they’re the people who are going to be successful or otherwise in what they set out to achieve. Does what they want to do make sense? What due diligence have they done?’
Although it’s important to present a convincing case from the start, most banks say that funding is always available as long as there’s a sound business model in place.
‘The amount of customer requests that don’t get funded is small,’ says Lloyds TSB’s Richardson. ‘In my experience, if you’ve got a decent product, proposition and management team, you will find funding in some form or other.’
However, exactly what form that funding takes is far from a foregone conclusion and depends on the banks’ view of the risks involved, Richardson adds. ‘If you’re providing a loan in expectation of higher sales, or of a new product being terrifically successful, and there is no security or history of cash flow, those loans represent an element of equity risk rather than loan risk,’ he says.
‘In those situations, if the bank was to be the provider, it would look for higher returns, which might take the form of higher interest rates or equity, or both.’
Negotiating your terms of business
This is when negotiations can get sticky, as Carlton Bingo’s Perrins attests. ‘Negotiating with anyone about money is difficult,’ he says. ‘You need good financial advice and a good firm of lawyers.
‘With any lender, you have to watch the wording of the legal agreement. You don’t want to be left exposed as a business to anything that could come out of the woodwork and bite you.’
It’s also important to consider the impact that repayments will have on your business. Neil McGowan, non-executive director of engineering investment company Southern Bear, can testify to this. In the past year, Southern Bear has made two acquisitions at a cost of more than £8 million, half of which was funded by term loans from its bank. Formerly a shell on AIM, the company is now making profits of over £2 million a year from a turnover of around £12 million.
Nevertheless, McGowan has a word of caution for businesses setting out on the acquisition trail. ‘Our first loan has a three-year repayment period, while the second is for five years,’ he says. ‘These are enormous chunks of money to pay back, and when you’ve just acquired a business it’s not easy to go straight into quarterly repayments.
‘Although very few banks offer this now, a chunk of overdraft, say £1 million, as a back-up is very much more helpful than a fixed-term loan. That’s what we’ll look for on our third acquisition!’
Types of protection banks require
Another crucial element of the deal is the security offered, if any. Baldock of Barclays explains that, from the bank’s point of view, not all security has equal credibility.
‘Property, usually the business’s commercial premises, is by far the best security,’ he says. ‘You start with the property and see what security that can provide. Many banks have standard loan-to-value ratios, which might be 70 to 80 per cent of the value of the property.
‘If customers need more, we look at the debtor book, then assets such as a fleet of cars. Another way is cross-collateralisation with other companies: if an entrepreneur’s got five companies and sets up a sixth, you might choose to secure against the assets or cash flow of the other five.’
The least attractive type of security, from the entrepreneur’s point of view at any rate, is a personal guarantee. ‘Obviously, any entrepreneur’s preference is for other means of security than putting their own personal wealth into play,’ Baldock adds.
After all possible security has been exhausted, banks may consider unsecured lending (euphemistically known as “leveraged lending” or “cash flow lending”), which will be priced at a higher rate. According to Baldock, the credit crisis has certainly not made life easier for businesses with little security to offer.
‘There are some banks – not us, I’m happy to say – that have stopped this form of lending altogether,’ he says. ‘We ask a lot of questions before lending against cash flow, but higher-leveraged transactions do occur.
‘The larger the company, the more willing we are to offer them unsecured lending, because they have more products, more customers and more markets, which takes some of the volatility out of the business.’
The consensus seems to be that, although the credit crunch may affect how deals are structured, and their pricing, the banks are still very much open for business, and in Woolfson’s words, ‘desperate to invest’.
According to Baldock, banks have learned their lesson from the last credit crisis. ‘At that time, many banks – and if I’m honest, Barclays among them – damaged their reputations by panicking and calling in loans too early. We hold our hands up: we made mistakes in the past, which we hope we’ve learned from. We have no intention of panicking and shutting down businesses at the first sign of trouble.’