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.