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.”

The Current Situation and K2’s Recommendations for the Autumn Budget Statement

Calls for measures in next week’s Autumn Budget Statement to stimulate the economy are growing louder by the day.

Sadly, the news has been unrelentingly gloomy since October, when Public Sector jobs cuts showed a reduction of 110,000 between March and June, the rate of cuts five times higher than the OBR’s prediction, while job creation in the private sector was only 41,000.

On 14 November, the CBI’s latest employment trends survey found that 47% of employers were relatively optimistic, predicting their workforces would be larger in a year while 19% predicted they would be smaller, a positive balance of +28%.

But then, on 16 November against the background of the Eurozone debt crisis, the Bank of England revised down its growth estimate to stagnation until mid-2012 and only 1% growth for the year as a whole.

The ONS unemployment and employment figures on 19 November showed unemployment at its highest ever total of 2.63 million. From July to September a record 305,000 employees had gone from the economy and in the same period 100,000 people became self employed making a record high total of 4.09 million.

Are these people with a burning ambition to start their own business or have they simply given up on the increasingly fruitless search for employment and set themselves up as freelance sub-contractors or consultants?

As lending conditions continued to tighten, particularly for the country’s SMEs, Project Merlin again undershot its target and companies continued to pay down debt rather than investing.

By 20 November, the CBI, too, had had a rethink, reporting that firms were now reviewing investment plans after a “sharp fall” in confidence with 70% of senior business leaders now less optimistic about the future and two out of five freezing recruitment or laying off staff.

This does not suggest that the private sector is either in the position or the mood to create the additional employment that the government hoped would mop up the public sector job losses.

While not wishing to contribute further to the doom and gloom, it is difficult to find anything positive to say about the current picture and therefore this post adds to the growing calls for a “plan A-plus”  to stimulate some growth. What business desperately needs is some stability to restore confidence.

Our wish list includes measures to encourage small businesses to build capacity for growth by making it easier for them to employ and train people. Initiatives such as a NIC holiday for new employees, or young employees, training grants and relaxing termination obligations will make it easier for employers to justify taking on staff.

We also need measures to encourage export, particularly to areas outside the Eurozone, such as export trade credit, marketing support, trade delegations and export tax credits.

Finally small businesses need to be able to fund their investment in growth via a level of credit easing. The Government initiative of demanding that banks make loans to SMES under Merlin, while at the same time requiring them to reduce risk, is a farce. There are a number of possible initiatives but the Enterprise Finance Guarantee scheme hasn’t worked and the Small Firms Loan Guarantee Scheme (SFLGS) that it replaced did work. We advocate a reintroduction of the SFLGS.

Times are Tough for Commercial Landlords

Commercial landlords are coming under pressure from all sides in the current economic climate.

The plight of those landlords in the retail sector has perhaps been the most widely publicised as more and more empty shops appear on the High Streets where retailers have either ceased trading or moved out of expensive and badly performing outlets.

The problem for landlords is the double pressure of receiving no rent for their empty properties while still being liable for paying expensive business rates, calculated at approximately 40% of estimated annual rental value, a considerable burden.

Recently Dixons, owner of Currys and PC World, revealed that it had agreed with some of its landlords, to pay rent of just £1 a year in exchange for Dixons continuing to pay the business rates. Dixons is not the only retailer with business rate only deals with landlords.

Problems are not only in retail, however. Many commercial landlords are struggling as their tenants downsize, restructure or go out of business altogether, leaving empty industrial and office units for whom new tenants are hard to find. They still have to service their own loans as well as securing their empty premises and paying rates.

Added to this is the change in attitude among lenders towards property companies. Property loans are generally provided by banks who are now asking for much more equity and much better tenant covenants with evidence of a secure income when considering new or renewal of commercial mortgages. Banks themselves are already overloaded with vacant and distressed property assets.

The confluence of pressure is leaving many commercial landlords completely boxed in and adding to the problem is the amount of commercial property on the market.

A related issue is the number of businesses that cannot be sold because of an existing lease obligation. Buyers often want to downsize and therefore are seeking to renegotiate lease terms before purchasing the business.

There are formal and informal restructuring options that can be used to help commercial landlords who are dealing with vacant and loss-making properties but restructuring property portfolios is a complex process and every single situation is different.  This is a situation that requires the knowledge and skill of an experienced restructuring adviser.

Falling Confidence Among SMEs Supports Evidence of a Long L-Shaped Recession

Recently released insolvency figures show relatively little change year on year, suggesting that the debate about whether the recession would be a V-, U-, W-, or an L-shape Is now over.

It is four years since the economy collapsed and the evidence is piling up that it is flatlining. Whatever the technical definition for coming out of recession may be (ie two successive quarters of growth), a growth of 0.2% for the UK economy means it continues to bump along the bottom of an L-shaped economic decline, whether it is called a recession or not.

Had the recent decline followed the pattern of previous ones the numbers of insolvent companies would by now be climbing noticeably, as they are generally held to do when an economy is on the road to recovery.

However, the latest CBI quarterly survey shows a sharp decline in confidence among small and medium sized businesses, reporting flat domestic orders in Q3 and export orders down by 8%. They expected domestic orders to fall by another 4% in the final quarter, no growth in exports and were indicating intentions of reducing their stock holdings – hardly suggestive of any optimism there.

Perhaps the most interesting feature of the just released quarterly insolvency figures is the noticeable increase in the number of Company Voluntary Arrangements (CVAs) relative to the numbers of companies in Administration as going concern formal insolvency procedures. Compared to the same quarter last year, CVAs rose by 29.6%, while Administrations rose by only 6.3% perhaps reflecting the adverse publicity over the use of Pre-Pack Administrations.

Many commentators are predicting a lot of insolvencies lining up for the end of Q4. Since a rise in insolvencies traditionally indicates the emergence from recession, perversely, this suggests that they are being optimistic rather than pessimistic.

But if the economy doesn’t recover and there is a rise in corporate insolvencies, this will be truly damaging for the UK. There is a huge difference between insolvency to restructure a business to prepare it for growth and insolvency to close it down.

Continuing low interest rates and no discernible evidence of banks or other creditors really piling on the pressure, nor any sign of the restructuring that normally indicates the bottom of a recession, plus the plummeting confidence of the country’s SMEs, suggest that the economy will bump along the bottom Japanese-style for the foreseeable future at best or will decline further at worst.

The Roller-coaster That is Magazine Publishing

The magazine publishing industry has been on a roller coaster ride for many years as print advertising revenues have plummeted, driven partly by a shift to online advertising but more recently by the drop in marketing budgets during the ongoing economic crisis.

This year alone, Sky has discontinued all its magazine titles, each of which had a circulation of £4 million. BBC Worldwide has sold 34 titles to a private equity company. Future UK closed eight titles in July, citing a decline in revenues particularly in the US, and the UK-based B to B publisher Schofield closed its US operation completely, allegedly because the US division’s bank withdrew its finance.

Publishers have been suffering from a triple whammy, of diminished advertising revenue, increased newsprint and ink costs, while simultaneously trying to service residual debt taken on during the good times. 

Yet some publishers remain up beat. London-based B to B publisher Centaur Media has announced that it will double the size of the business in three years by focusing on buying up exciting new businesses, paid-for subscription services and events. Centaur restructured into three divisions in June and says that by 2014 it will double its revenue, the proportion of money it makes from online media and its operating margins. It also plans to reduce its reliance on advertising and shrink the contribution of printed media from 43 percent to 16 percent.

The question is whether it will succeed. We know of one publishing company currently going through a restructure that had been growing over the last two years.  It has a defined circulation B to B market with publications funded by advertising revenue. However, despite its current profitability it is carrying huge liabilities built up over two years of loss making while the business was growing. The sad fact is that this publishing company was undercapitalised and as a result its suppliers have funded its growth and are now exposed as unsecured creditors.

The raises the issue of growing liabilities in an industry where revenue is declining and supplier costs are rising. The potential for a publishing house to drag a lot of suppliers down with it is huge. Restructuring such companies is also difficult since cutting editorial costs has an impact on quality and relevance to readers.

Clearly the industry will need to be much more innovative if it is to survive and prosper. One obvious tactic, as illustrated by Centaur, is to shift some titles to being online only.  Others are making some online sections accessible by subscription only and charging for special reports and in-depth industry information. Other innovations could include experimenting with outsourcing writing overseas, outsourcing sub editing and page make up and printing abroad.

Readex, which regularly surveys attitudes among B to B readers recently reported that 74% wished to carry on using print versions of the titles they read so there is plainly life in the B to B publication market. Professionals will always need to keep up to date with their industry’s developments and the activities of competitors.

Nevertheless, the print side of the industry is likely to decline. Publishers will need to be more innovative and change their business model, most likely embracing alternative media that does not rely on printing and physical distribution.