Update

In view of our comments in the last item it is no surprise, therefore that the struggling music, films and games retailer HMV has announced today (December 13 2012) that it is in talks with its banks, following a 13.5% reduction in sales in the six months to October and amid fears of a “probable” breach of its banking agreements next month.

Whether new initiatives put in place by the company’s new Chief Executive, Trevor Moore, who took up his post in September, will be enough to help HMV take advantage of the run-up to Christmas to significantly improve on sales remains to be seen. Like many retailers it will have December deadlines looming.

Season of Goodwill?

December marks a “pinch point” for many businesses, particularly for the high street retailers.

The quarter day – when quarterly rents to landlords fall due – is on December 25. About then most businesses will be facing their next pay run of salaries for employees and possibly of payments to additional temporary staff who have been taken on to cover the festive season. Then there is a VAT return with VAT to pay on the Christmas trading.

If all has gone well the seasonal stock will have been run down and there will be a lot of cash in the bank from the Christmas trading.

The question is what will the banks do at this point? Are they lining up to pull the plug on businesses at the point in the year when their clients have most cash? Or the point when their clients have significantly reduced the overdraft? Arguably Christmas is the best time for a secured creditor, such as the bank, to call in its loans, or reduce the overdraft. The banks don’t even need to pull the plug, they can just take the cash to offset a loan or simply reduce the overdraft facility.

With banks seeking to repair their balance sheets and the uncertainty ahead, are we likely to see a sudden upsurge in insolvencies immediately after the Christmas period?

It is estimated that 160,000 businesses are classified as ‘zombie companies’, defined as those who are surviving by only servicing interest with little prospect of ever repaying the loans. Since the start of the recession it may not have been in the interests of the banks as secured lenders to pull the plug, however Christmas can be the best time for them to consider such an option.

Companies who are just servicing interest ought to be concerned. They ought to be seeking advice before the bank swoops.

Crowd Funding has a Key Factor that makes it Attractive to Firms Seeking Cash

The plethora of Government initiatives designed to stimulate lending to small enterprises and StartUps, seem to have mainly sunk without trace as the economic meltdown continues.

From Project Merlin, via the National Loan Guarantee Scheme and others including the latest initiative, Funding for Lending, they have largely been ignored by both banks and companies.

Throughout the downturn the banks have said they are willing to lend, and most commentators have claimed there is no shortage of finance, however business lending has continued to decline.

There seem to be two main issues that have caused the decline, firstly the banks are more cautious and want both security for the loans and business plans that demonstrate they will be repaid, and secondly companies remain uncertain with few applying for loans unless they are in financial difficulties.

Similarly investors have been somewhat absent from the market. Many have already been wiped out leaving those with cash very wary.

Despite the tax relief incentives offered under the Enterprise Investment Scheme (EIS), and for StartUps, the Seed Enterprise Investment Scheme (SEIS), there has been little interest. This lack of appetite can be explained by the stringent pre-qualifications. In the case of StartUps, SEIS investors may qualify for 50% tax relief on up to £100,000 however the HMRC guidance notes may help explain why no one is excited: http://www.hmrc.gov.uk/seedeis/index.htm

There has however been much excitement over a newer funding alternative called “Crowd Sourcing” or “Crowd Funding” since the launch of the UK version of the US enterprise Kickstarter on 31 October 2012.

While Crowd Funding may prove to be a good option for many firms, StartUps in particular should do their research. Kickstarter, for example, is restricted largely to creative projects that have a defined beginning and end and its website clearly states: “Starting a business …does not qualify as a project.”

This innovative type of funding is becoming more common. There are already several finance providers each with its own criteria and the number is likely to grow as investors and lenders put up more cash.

The Crowd Funding providers appear to have one common factor that makes them attractive to firms seeking cash. They make it simple to apply for finance, whether debt or equity.

Beware! Disputing a debt may not stop a Winding Up Petition

It is not enough to dispute a debt when dealing with a creditor’s Winding Up Petition, it is the disputed amount of the debt that matters.
A recent case involved a complex debt that was disputed where the Court made a Winding Up Order on the grounds that it was satisfied that more than £750 was undisputed.
While the High Court does not like creditors to use petitions for debt collection by putting improper pressure on a company, the Court does not have to resolve the dispute or agree how much is actually owed if it is satisfied that more than £750 is due.
£750 is the threshold amount needed for a Court to make a Winding Up Order.
All too often companies fail to deal with a creditor long before the hearing for a Winding Up Petition, where they have plenty of opportunity throughout the process to halt proceedings if the debt is disputed or to pursue a restructuring option if the company simply cannot pay the debt.
In most situations where creditors are pursuing overdue debts, and in all cases where a Winding Up Petition is served on a company, help from an experienced turnaround and recue adviser is needed if the company wishes to survive.
Companies should not believe that simply disputing a debt is in itself enough to ensure that such a Winding Up Petition will be dismissed.

Banks need an incentive to lend to Entrepreneurs and SMEs

Despite government rhetoric and its promotion of initiatives to encourage bank lending to entrepreneurs and SMEs the banks aren’t lending.

Merlin is a joke and contributes almost nothing to stimulating growth or an entrepreneurial culture in UK.

The root of the problem is banks’ inability to lend to businesses with few assets.

The Enterprise Finance Guarantee (EFG) scheme has not worked and nor will the new National Loan Guarantee Scheme (NLGS) initiative because lending because neither is underwritten by a Government guarantee, thereby exposing the banks to the full credit risks.

How different from the Small Firms Loan Guarantee Scheme (SFLGS) launched in 1981 to stimulate lending to SMEs, where the government provided a guarantee to the banks to support the lending.

The conception of the EFG and NLGS appears to convey a Government guarantee, however it doesn’t and this is why the banks are not lending under these schemes.

The SFLGS provided for a government guarantee to the lending bank of 85% of unsecured loans to qualifying SMEs who could borrow up to £250,000 (70% for companies under 2 years old).  During the 1980s – 90s the SFLGS contributed to stunning growth, helping to encourage entrepreneurs to set up and grow their business.

It was scrapped by Gordon Brown in 2006; a nail in UK’s entrepreneurial coffin, and such prescient timing.

Banks have the funds and the distribution networks, but they should not be exposing themselves to risky or unrecoverable debt and therefore are rightly wary of unsecured loans.

They need to be incentivised to lend to SMEs. Their loans need to be underwritten and the government is the only such source. Bring back the SFLGS.

Is the Economic Recovery Being Imperilled by Banks’ Continued Failure to Lend to SMEs?

Despite government rhetoric, evidence continues to pile up that the banks are still not lending to Small and Medium-sized Enterprises (SMEs).

We are hearing that when companies apply for any lending the banks are only considering loans or overdrafts secured on tangible assets, with most also demanding personal guarantees from the directors in addition.

Total net lending by the UK’s five main banks fell in 2011 and they missed their lending target to small firms, whose use of bank overdrafts and loans has also declined over the past two years.

The FSB reports that of 11,000 SMEs just one in 10 obtained a bank loan in 2011 and that 41% of applicants had been refused loans in the three months to February 2012. The FSB believes the UK banking system is not geared up to lower end loans of less than £25,000, because “there’s no money in it”.

Business Secretary Vince Cable has warned that recovery is being imperilled by the “yawning mismatch” between bank lending and SME demand for finance and at the end of April economists at Ernst and Young predicted that they expected lending to reduce further this year by 6.8 per cent, to £419 Billion.

Meanwhile invoice discounting and factoring have increased significantly, though banks are seemingly no longer offering these facilities, leaving the door open for independent companies such as Bibby, Close, Centric, SME, Ulitmate and the new British bank, Aldermore.

Are the banks struggling or are they simply withdrawing from the SME market?

We think the banks are being deceitful. Whatever the rhetoric, they are using PR tactics to report new loans, which are in fact not really new lending but the refinancing of existing facilities such as turning an overdraft into a term loan or a factoring facility.

This is piling even more pressure onto small businesses because there is a net decline in the flow of money into SMEs, and furthermore any new money is being provided at a very great cost in terms of fees and interest. While high rates of lending may be justified by the risk when it is unsecured, it is not justified when the loan is secured.

K2 would be very interested to hear from SMEs that have managed to secure a bank loan.

Beware of Directors’ Loan Accounts

Accountants often advise clients to use directors’ loan accounts as a device to help minimise their personal tax liabilities. However, be warned, they only work when the directors are also shareholders and the company is making profits.

Essentially they involve the directors borrowing money from their company and drawing only a minimum salary through their company’s payroll. The loan account is paid off by declaring a dividend and this is a legal way for directors to minimise their personal tax and it avoids having to pay employee and employer NI contributions.

This is fine when a company is profitable but it can become a problem if the company does not have sufficient profits as distributable reserves that can be used to clear the loan.

We are coming across increasing numbers of companies that have not made a profit and where the loan cannot be cleared, leaving the directors effectively owing money to the company.

This can be a serious problem if the company is hoping to reach a Time to Pay (TTP) agreement with HMRC to defer payment of corporation tax, PAYE or VAT because HMRC generally stipulates that such loans are repaid as a pre-condition of approval.

Similarly, when proposing a Company Voluntary Arrangement (CVA) or when a company becomes insolvent, the appointed administrator or liquidator will most likely ask the director(s) to repay the loan. Before approving a CVA, experienced creditors particularly HMRC also tend to demand repayment of directors’ loans.

It is often forgotten that such attempts to reduce tax carry the risk of creating a huge personal liability. To avoid it, we recommend that such dividends are declared in advance so as to avoid a loan or at least regularly to avoid building up a huge directors’ loan account. This avoids the normal practice of waiting until long after year end when the annual accounts are prepared, during which time the company may incur losses that mean dividends cannot subsequently be declared.

A further note of caution relates to any directors’ loan account outstanding at the company year end, which will be highlighted to HMRC in the accounts. Despite any intention to reduce the tax liability, tax legislation seeks to limit the benefit by imposing a section 455 CTA 2010 tax liability (under Corporation Tax Act 2010, formerly s419 of the Income and Corporation Taxes Act 1988). While this tax can be recovered when the loan is subsequently repaid by the director, whether in cash or as a dividend, it triggers a significant tax liability on the company.

Build a Flexible Marketing Model to Ensure Perpetual Growth

Following on from the flexible business model that we developed to ensure the perpetual survival of businesses it makes sense to explore how growth can be achieved with flexible marketing without ‘betting the farm’.

The principles of flexible marketing are similar to those of survival as they involve tight cash management and being aware of the fixed nature of many contracts for promotion initiatives that either don’t work or become a financial burden.

Marketing can be complicated and there are lots of alternative ways to achieve marketing objectives where it is often difficult to measure success in terms of ‘return on marketing spend’ or ‘bang for buck’ when developing a marketing plan.

Marketing activities can serve a number of purposes which makes measurement even more difficult. The model that works best will be different for every business, but when markets are so uncertain and cash is tight marketing can make the difference between failure, survival or growth. The key is to understand then manage the relationship between cost and return for different marketing activities. Flexibility reduces the cost of switching between activities which in turn reduces the cost of getting it wrong.

Possible marketing objectives include generating new sales leads, selling different products or services to existing customers, launching a new product, persuading potential customers to buy from you, or reassuring clients by building a reputation, particularly for those firms selling advice or professional services when they want to set up or move into a new geographical market.

Having established your purpose and defined objectives you need to consider various marketing initiatives, affordability and how they might be measured in terms of cost and outcome. Essentially flexible marketing is based on a process of trial and error where you can afford to get it wrong.

Simply placing a single advertisement can work for some firms even if it is expensive, providing the results justify the cost.

Affordability versus flexibility can be an issue especially when payment is spread over a period of time. While flexibility is likely to cost more, most initiatives can be easily trialled and measured without the need for a long-term commitment to test whether they work, e.g. pay per click such as Google Adwords, internet banners, leaflets, posters, adverts on print, radio or television, redemption vouchers, point of sale promotions, text based promotions, stands at trade fairs and even short-term rent or pop-up shops.

Less easy to measure are longer term marketing initiatives such as publishing articles in online media to generate visits to a company’s website. Similarly public relations and press releases to relevant media can generate press interest that raises awareness but may not produce immediate sales. These are more speculative, need not be expensive and can help establish a reputation for the business as an expert in its field. They offer longer term benefits since they tend to be picked up by search engines and therefore have a long life. Using such methods will depend on whether the business firstly can afford to invest the money and secondly is looking to a longer term return than immediate sales or orders.

Whatever initiatives are deployed, the marketing mix needs to be continuously reviewed and refined in exactly the same way as applies to using a flexible, cost sensitive business model.

Add a flexible marketing model to a flexible business model and you can both ensure perpetual survival in a difficult economic climate and perpetual growth.

Build a Flexible Business Model to Ensure Perpetual Survival

While businesses might be concerned about a eurozone Armageddon, whatever the outcome they will need to ensure survival for the period of austerity that is likely to characterise the next decade.

Although growth is desirable, and has been the purpose for many businesses, a more realistic objective in times of uncertainty is to stay in business for the next five years.

Arguably the best way to achieve perpetual business survival is to avoid running out of cash. This involves examining all cash commitments and where possible turning fixed costs into variable ones so as to reduce the breakeven level of sales necessary to cover overheads and fixed obligations.

Long-term fixed obligations include fixed-term rents, hire-purchase or lease agreements, repaying loans, servicing interest, supply contracts and staff employment. Common examples of where companies have taken on such commitments tend to relate to: offices, plant and machinery, IT equipment and software, vehicles, signage, furniture, printers and photocopiers, mobile phones and telephone systems.

Most companies also fail to cancel or at least review contracts that automatically renew, such as: IT equipment and plant leases, life insurance, medical policies, employee benefits, subscriptions and membership, servicing and maintenance, office and window cleaning, sanitary towel and waste removal, portable appliance testing (PAT), health, safety and fire extinguisher inspections and so much more.

The key message is to review every payment and check whether it is necessary and you are not being overcharged.

While it sounds counter-intuitive, businesses often make more money by reducing sales. It is worth looking at the quality of contracts and the quality of customers. The benefits from focusing on only those contracts and customers that provide an adequate profit, that pay well and pay on time can be considerable.  Gross profit margins are increased, overheads are reduced by not having to chase payment and less cash is needed to fund pre-sale payments and post-sale credit. The flexible business model means that you no longer need to take on unprofitable work.

All too many companies are too focussed on chasing sales (and tails) to review costs and find ways to reduce them so reviews should also look at other ways to cut spending. Huge savings can be made on travel and communications costs by using internet-based phone and video conferencing facilities like Skype or VOIP services, for example.

The flexible business model is based on a principle of not having to pay out cash if there is no cash coming in. It needs leadership and teamwork but a focus on improving profitability, on reducing costs and on converting fixed overheads into variable ones means that a business can achieve perpetual survival.

Norman Tebbitt said “Get on Your Bikes”, we Say “Get on a Plane”

Optimism has been in short supply as 2011 comes to its end and businesses will need to be even more innovative and proactive if they are to survive and grow in the face of the gloomy economic predictions of stagnation for the next few years.

The ONS says industrial production fell by 0.7% in October in contrast to a rise of 1.7% in October 2010. The OBS downgraded its growth forecast for this year from 1.7 per cent to 0.9 per cent and from 2.5 per cent to 0.7 per cent for 2012 and the OECD predicted that the eurozone economy will shrink by 1% in the fourth quarter of 2011 and then by 0.4% in the first quarter of next year.

By contrast to the above, HMRC’s latest figures for UK exports show non-EU exports grew in September by £0.4 billion (3.4%) more than August while exports for the EU increased by £1.6 billion (13.4%).  September’s non EU exports were worth £11.3 billion and the month’s exports to the eurozone were worth £13.6 billion.

Although both figures show a slight improvement on August 50% of UK exports go to the eurozone.  Given the ongoing turmoil in the eurozone it would be foolish for UK business to continue to rely so heavily on Europe being able to continue taking such a large share of UK exports, let alone support any growth.

Currently the UK imports more than it exports and the trade gap with areas both inside and outside the eurozone is increasing both monthly and year on year.

Investing in UK businesses has become too much like bank lending. Instead we need a culture that rewards risk-taking and celebrates those who profit from risking their own capital. Most people in the UK want to invest in land and property as a long-term safe haven for their capital. Neither the culture, nor the tax incentives encourage us to invest in exciting business ventures. We are not encouraged to be adventurous for the future of UK plc. Ideally set up some meetings before travelling but you really do need to get on a plane if you want to find new customers.

UK businesses in both manufacturing and service sectors have become too reliant on the domestic market and need to look overseas, well beyond Europe. We should revive some of the spirit of our Victorian forefathers.

In an echo of former MP Norman Tebbitt’s famous advice to the unemployed to “get on your bikes” K2 says businesses should “get on a plane”.

We need pioneering Business Heroes prepared to explore foreign lands and open up new markets to sell our goods and services to countries that have potential for real economic growth. Are we still hoping that business will come to us? The world has changed and we must go out and start finding it.

Regime change in North Africa and the Middle East offers some terrific opportunities, while elsewhere, such as the BRIC countries, people are thirsting for the standard of living that we take for granted.

To those readers who are saying “yes, but…” to this argument, the reply is: “our forefathers conquered the world.  They took risks and it’s time we started taking some ourselves. We need to rediscover our spirit of adventure.”