Recession, Review, and the Application of Corporate Finance
A recession or similar downturn is absolutely the time to do a root and branch review, “lift the drains,” and spring-clean the business. Why? Two reasons: First, because you have more time to do it during a recession; and second, because having done so, you will emerge lean and mean when the economic cycle turns favorable once more.
So often, corporate finance is transaction-led. Most accountants routinely offer the corporate finance services listed at the top of this article, but (and not just in the application of theory) there are many more opportunities, both holistically and in detail, to add measurable and lasting value to the business—and better understand it—if a corporate finance transaction starts with strategy and a thorough business review.
Business and Financial Reviews
Any accountancy firm worth its salt can do a financial review of sorts. This would probably focus on the profit and loss account, or tax, and how you can thereby save money. But the central focus of corporate finance is much more on the balance sheet. For example, an acquisition needs financing, either by debt or equity, or by both. Both need to be seen in the context of and integrated into the existing financial structure of the balance sheet.
A thorough financial review should ideally begin with a thorough business review. Every financial transaction is the consequence of a business decision. The business review starts with a review of strategy—especially the marketing strategy. It can go all the way through to the business processes and the systems that support them.
It’s rather too simplistic to think that corporate finance transactions result solely from a need such as raising more working capital, financing capital expenditure, saving tax, selling or passing the business on, etc. Even if these are the circumstances that trigger a corporate finance transaction, each transaction should still be preceded by a thorough business and balance sheet review to see how it fits into the whole and ensure that the overall goal of maximizing the return on the balance sheet at a managed level of risk can be achieved.
Corporate Finance in a Credit Crunch
Credit shortages and squeezes are not unusual; they typically follow a credit “bubble,” where credit has grown so fast that it necessitates an economic readjustment. More importantly, the recent credit crunch has actually been a liquidity shortage. Funds have been scarce and the cost of borrowing has gone higher because the banks could not raise sufficient, or even any, longer-term funds to lend to business.
The smaller the enterprise, the harder it is to raise sufficient funds and the higher the likely cost. It’s hard enough that the economic slowdown has squeezed financial performance. Being unable to find additional funds readily when they are most needed can all too often lead to business failure. It’s not lack of capital but lack of cash that busts businesses. So creativity in corporate finance becomes even more important.
So What Can SMEs Do?
Few SMEs have the opportunity to float via either an Alternative Investment Market (AIM) or full listing on the London Stock Exchange. Furthermore, the new issues market is unlikely to return to anywhere near normal before 2010. Most corporate finance transactions for SMEs involve rather less finance than might be raised through an IPO (initial public offering, or flotation).
One factor that unites all SMEs is the need to find and manage working capital. Many are wedded to the idea of unsecured debt—usually an overdraft. Some will even resort to moving banks just to get a bigger unsecured overdraft facility.
This may not be the most efficient or, especially, the cheapest means, however. The credit crunch produced some fundamental changes in the commercial and corporate banking markets (many UK bankers refer to finance for companies with turnovers of up to $1.5 million as “commercial” and above that level as “corporate”; there is no real difference in principle). First, it accelerated the transition from overdraft finance to invoice discounting. One of the key reasons for this was because in most cases banks wanted security for the debt.
This security can take many forms. The most common is assets—property, machinery, other capital assets, cash, stock, receivables, etc. The practice of taking unsecured personal guarantees has decreased, but banks may routinely ask for a statement of personal assets and liabilities. Ideally, they prefer to take a charge on personal assets, such as the owner’s or director’s house.
Parallel with these changes has been the move away from base rate related finance. At the worst of the credit crunch, Libor (the London Interbank Offered Rate, i.e. the rate at which banks lend each other money) diverged by up to 1.6% from base rate (usually equal to the Bank of England Base Rate as reviewed and set by the FOMC monthly), so banks preferred to use Libor as the basis for their lending rates. It also allowed them to blur the edges from one bank to another, as opposed to the common metric of the base rate.
So unsecured overdrafts became relatively dearer (up to 5% or more above base rate) and invoice discounting relatively cheaper (as low as 1.2% over base rate, although it rose as high as 2% above as Libor diverged).
The Cheapest Form of Working Capital
The cheapest form is that generated by the business itself, i.e. from sales. It is amazing how many SMEs approach their advisers or bankers seeking to borrow more money for working capital purposes when they could devote more time to selling and less to administration. This is the principle of working in the business rather than on the business. Sir Alan Sugar, the British entrepreneur and businessman, is not alone in referring to the concept of the “busy fool”—someone who works long hours and makes little or no profit.