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CHAPTER FIVE: BANK MANAGER'S PROTOCOL ANALYSIS OF THE CASE MATERIAL
Introduction
5.1 The research team, with assistance from the Scottish Government, approached the four main commercial banks in Scotland. Three of the commercial banks agreed to participate, for which the research team and the Scottish Government are very grateful. Participating banks included the Clydesdale Bank, the Bank of Scotland and the Royal Bank of Scotland. These banks have the largest market share of SMEs as banking customers in Scotland. In addition to the participating banks, an independent banker, who was formerly a senior executive with national responsibilities for business finance, was involved at an initial stage to verify the case material, the interview structure, the nature of questions, the nature of analysis to be expected in each of the cases, the criteria that should be applied and that nature of process and protocols that were likely to be applied. As a result of this verification stage, one of the proposed cases was dropped from the portfolio of case material. This case had limited information and it was considered to be difficult to present to bank managers. The interview structure was also validated and amended.
5.2 Five case studies of firms whose applications for finance were rejected were eventually selected for analysis by the participating bank managers. These five cases, after verification from the independent banker, provided a varied range of scenarios (see narratives below), size of business, turnover and credit requirements. Four of the five cases had extensive financial information. One of the cases was included as a narrative only (case 4). Although the narratives for each of the cases were anonymised, in order to handle sensitivity issues, additional financial information, including in one case a full business plan, was sent out as hard copy by courier or post in advance of the interviews. Eight bank managers from the three participating commercial banks took part in this stage of the research. They all received the case studies in advance of the interview together with the interview structure. All banks segment the SME business market, generally on the basis of the size of the business, which resulted in the division of cases for one of the participating banks between the bank managers. Extensive pre-interview work and time was, therefore, completed by each of the eight bank managers and all interviews were conducted face to face by members of the research team from PERC, each interview taking up to two hours.
5.3 The methodology employed by the interviewers was one of verbal protocol analysis (explained in section 1.3 above).. We invited each of the bank managers to talk us through how each case would be dealt with, the processes involved and to give their views on the strengths and weaknesses of each case, together with an indication of the level of interest and how the case would be taken forward if that was appropriate. It is important to mention that, for each case, the managers' were unaware of the eventual outcome. This methodology formed the first part of the interview with the pre-seen case material. This was supplemented by the second part of the interview with a semi-structured questionnaire to reveal additional findings on issues on SMEs' finance from the bank managers' perspectives including start-ups and established customers.
5.4 The rest of this chapter details the findings from the case study protocol analysis with summaries and separate comments for each of the five case studies. The discussion of each case is preceded by a descriptive narrative of the business and the reasons for seeking finance. Following the discussion we give a summary of the actual outcome of the finance application and the business owner-manager's views on the relationships between SMEs and banks more generally.
Protocol Analysis
CASE 1
NARRATIVE FUNDING REQUIRED : £1 million for new product development PROFILE OF BUSINESS This is a manufacturing company which was established in 1998 as part of an employee buy-out of the manufacturing division of a larger company. The main business activities of the company are subcontract manufacturing and gas generation equipment. The company has specific expertise in the product design and development, metal transformation/fabrication and electronic/mechanical assembly and testing. The company's activities can be split into three main areas: (i) Solutions Business: within this sub-contract business, the company works mainly for a large multinational company in the UK, Canada, China, Brazil and India. Turnover from this aspect of the business was £10.1 million in 2005 of which 71% came from this single customer. There is a real expectation of increasing the Solutions Business to over £17m over the next two to three years. (ii) Gas Generators: the company has a product range of gas generators that supply high purity cases suitable for use in laboratories and the food and drink industry. Annual sales of laboratory gas generators such as those produced by the company are estimated to be $30m worldwide. (iii) Midgeater and Midg-it products: These are products designed and manufactured in house and intended to attract all disease bearing insects such as midges in the UK and mosquitoes in Africa and the Far East, through a gas generated scent of carbon dioxide. The company has now established two distribution partnerships with Calor Gas for the UK and Rentokil for the Far East. The company sold 3,000 units of these products over the last 18 months and as a result of its marketing programme and a strengthening of its distribution network expects an increase by 50% in FY06 and a further 30% in FY07. The company now has an international customer base, with customers in Canada, South America, Europe and the Far East The company employs a total of 150 people (148 working full-time while only 2 of them are working part-time), having grown from 84 employees in 1998. The management have been actively trying to grow the business during the last two years, although shortage of cash has been the main factor constraining sales performance. Despite this, the objective remains to grow the business. NATURE OF THE BUSINESS CASE New products The company requires finance from the bank in order to help them to further develop their insect catching devices. These will result in increased sales turnover, profit and the international "footprint" of the company. Currently these products account for less than 10% of the turnover of the company, but they have the potential to contribute more than 25% of turnover. The company has identified their customer product needs through market research, contacts, common sense and through experience of the business. There are several US based companies that offer similar products to the Midgeater, although many of them concentrate their sales effort on the US. The company will therefore be focusing its sales effort on other territories and therefore will not enter into direct competition with them. |
Interviewed bankers assessment
5.5 This case provided a range of issues for all the interviewed bank managers. It was of interest; strengths for all the managers being that it was well established, with new product development ( NPD) and an established management team. It was considered to be rather different from the 'normal' with an MBI/ MBO scenario, but with a professionally produced business plan. In terms of protocols, all the managers stressed the importance of getting to know the management team and understanding the nature of their business. It was felt essential in all cases that a visit would be necessary to the business premises to get to know the nature of the business, all the management team and an understanding of the purpose of the credit facility. Also, because of the nature of the history of this business, it would be necessary to understand the background, although if an existing customer, this would be known. As pointed out by the majority of the bank managers, the high dependence of the company on one customer for a high proportion of their turnover would have been a focus for further investigation in terms of understanding the nature of the management team's business. The participating banks all had a financial modelling computer-based system that would be used for a case of this nature. In all cases this was a fairly sophisticated modelling system that would produce a guide for decision-making, more in terms of a strength and risk of a proposition rather than accept or reject decisions (as for example would be the case with credit-scoring, see later discussion). In one bank, a case would need to be prepared together with the financial modelling result that included a narrative. This would then be referred to a central credit department. In general, the managers were uncomfortable with this case as a lending proposition, it was highly geared/leveraged with existing debt compared to equity funding and currently loss making. The NPD involved R&D which is an intangible asset. Partly as a result, there was a commonly held view that any security taken would have to be in the form of intangible assets or as a floating charge; that is a charge against non-fixed assets. (One manager also expressed a view that taking a floating charge had become more difficult since the Enterprise Act.) Diversification though was seen as a potential strength.
5.6 The importance of other financial and management information varied between the eight bank managers. There was some concern with the nature of a track record that included some acquisitions that had not been successful and the majority were concerned that the existing management team were 'technical', perhaps without marketing expertise. There was some concern at the nature of the sector, which was felt to be highly competitive. In addition, one banker thought that cost savings could be made by producing abroad, hence some concern with the existing location. The age of the management team was a factor for two of the bankers as two of the directors were nearing retirement and they were concerned to see a succession plan in place. However, the composition and nature, competencies and skills of the management team were important for all the bank managers, with one banker viewing the key staff as particularly important. Two of the bankers picked up that the business plan was prepared by a non-executive director. A number of the bankers thought that it would be necessary to bring in a more specialist team from the bank. All of them felt that they would need to get a better understanding of the finances of the business, including the nature and age of debtors and creditors. It would be necessary to 'drill down' behind the figures and to conduct some sensitivity analysis. Only one banker thought that it would be worthwhile to bring in specialist support agency advice, referring to the Scottish Manufacturing Advisory Service of Scottish Enterprise; otherwise potential advice/referral from support agencies was not mentioned. The nature of the order book was important for all the bank managers.
5.7 All the bank managers agreed that security would be necessary if this was taken forward, but this may not be possible (to cover the debt) given the nature of the business. More likely, it was considered that if taken forward the bank would seek to put together a funding package, and that additional equity would be required to make this feasible.
Overall Assessment
5.8 This was a difficult case for the bank managers to support having the combination of high gearing, previous loss-making activities, competitive sector and limited levels of security. Managers also disliked the high reliance on one major customer for a high proportion of the company's existing turnover. However, they could see that logically there was a case for diversification. Whether this proposition was supported would depend on whether it was an existing or new business customer. As a new business customer, without further equity it would be difficult to support and challenging. It would be approached with a good deal of caution and it was seen as relatively risky. If the company was an existing business customer, all the managers thought that the bank would seek to put together some sort of deal to help the company, even though it was recognised that this would be difficult. One bank manager considered that the track record of the company suggested that it was in an intensive care situation.
Comment
5.9 This case would almost certainly not be supported as a new business customer. Although all the bank managers that discussed this case had considerable authorisation limits, all new businesses had to be referred for final approval by a central decision-making unit. The financial modelling required would give a category that would be difficult to support. The nature of the development through R&D and NPD meant that the banks saw this as essentially something that was difficult for them to support, although a funding package of bank debt and equity was seen as a viable alternative. All the banks stressed the importance of getting to know the managers/directors, the business and its products. The nature of relationship management with the bank would determine whether it could be taken forward. This case would need to be referred for approval and the indications were that the financial modelling computer-based systems used by the banks would produce a high risk category proposition that would be difficult to make a case for.
Actual Outcome The company only applied to the bank that they normally used. Their application was turned down with the recommendation that they should approach equity investors instead. The main reasons for the refusal were: (i) the company was too highly geared; (ii) they were too dependent on one customer; (iii) they were in a high risk area, being a manufacturing business. The company had sufficient collateral to offer, but were not asked to do so. They were considered to have a good trading record, a strong business plan and cash flow projections sufficient to justify the application. The managing director felt that in retrospect the company could have put forward a stronger case. He felt that the bank was unfair by refusing the finance on the above grounds. He was of the opinion that banks take a cautious view in everything and worry too much about their exposure. Therefore, in general he considered the banks to be unhelpful to the success and growth of small businesses, especially manufacturing businesses. The company eventually raised half the funding it was seeking ( i.e. £500,000) from its existing shareholders which enabled the project to go ahead, but on a smaller scale. |
CASE 2
NARRATIVE FUNDING REQUIRED: £50,000 for the purchase of new packaging machinery and new computers. PROFILE OF BUSINESS This is a manufacturing company which began trading in 1992. The company is privately owned and specialises in manufacturing garden products. It has a turnover of £0.5 million. The main business activity of the company is the manufacture of garden products such as giftware, garden twines, ropes and display stands. (i) Giftware: this is a range of high quality design led giftware for gardens which was launched in 1999. This eclectic range of practical gifts utilises all natural materials where possible, incorporating wood, terracotta, jute, and cotton which are manufactured in the UK. (ii) Twines: this product range is fashioned using natural jute, which is biodegradable. They are packed in tins, which help to maintain the twine clean and tangle free. The company offers a comprehensive range of twines including jute, cotton, sisal and polypropylene, available in spools and balls. Its popularity with gardeners has grown significantly over the years as it is kind to plants. Twines are used for plant support, general gardening, commercial growing, decorative tying, craft use, ticketing, arts and crafts. The company employs 14 staff, all working full-time. The management has been trying actively to grow the business during the last 2 years and growth remains the firm's objective for the next 12 months. The company's brand of products is protected by membership of a trade association. Although growth is a business objective of the company, it is careful not to over supply the market in any one region, working in partnership with customers to ensure exclusivity is maintained within a selling area. Since the launch of the range of giftware for gardeners in 1999, the product line has been developed and grown to meet the demands of customers. The growth of the company is national as well as international in nature, offering a next day service throughout the UK mainland, and deliveries being made to ports for shipment worldwide. The main factor constraining sales performance of the company during the last 2 years is lack of finance. NATURE OF THE BUSINESS CASE Capital investment The company requires finance from the bank to enable them to purchase new packaging machinery and new computers. This investment will increase the company's productivity and efficiency. The overall profitability of the company will also increase significantly. Before reaching a decision to purchase the equipment, the company evaluated the capital expenditure proposal using various evaluation techniques such as monitoring the products on a daily basis, observing the market, assessing what competitors are doing and using experience of the business. Working capital The second reason for seeking funding from the bank is for working capital purposes. The company has a cash flow problem capable of putting it out of business. The major cause of the cash flow problem for this company is an outstanding debt of £300,000. However, the management of the company has been dealing with this problem by trying to boost sales through attracting more customers and by diversifying all the time. The profitability of the company has improved significantly. For example, the company was making a loss of £60,000 in 2005/06, but in 2006/07 the loss has reduced to only £6000. |
Interviewed bankers assessment
5.10 This case was relatively straightforward and was the smallest funding requirement of all the five cases sent to the bank managers. It was of potential interest, but would be dealt with by local business relationship managers. A representative comment was that they would not normally see a case like this. A number of features were picked up by all the bank managers. One of these, and of an immediate area of concern for all the managers, was the high level of debt compared to turnover, with the company having £300,000 debt against a turnover of only £500,000. A further issue being that the company was trading with relatively small, individually priced items. An attraction again for all the managers was that the company was well established. In terms of process and protocols, although a small company, the managers indicated that they would still need to see the management and get to understand the nature of their business. It was considered that this would help to establish the nature of the £300,000 debt, which was one of the major concerns, particularly the extent to which this might be a bad debt. If progressed, two of the bank managers, from different banks, considered that invoice discounting (or cash-flow discounting) would be appropriate for the company which would mean bringing in a specialist department concerned with asset financing. By contrast, other bank managers felt that this may not be appropriate due to the nature of the existing financing of the company. With the existing large debt, one banker considered that this made invoice discounting inappropriate because it was considered that if the debt is not insured, the invoice finance facility will be 'basically appointing a receiver or administrator.'
5.11 In terms of additional information required all the bank managers required three years' previous trading accounts including profit and loss and balance sheets. More detailed information would be required on debtors and creditors and credit terms, with an understanding of who is responsible for finance in the company, or whether this is completed by a separate accountant. This would then be followed by more understanding and information required on the management and key staff. One banker commented on how they liked to be able to judge people in an interview before progressing with a proposition of this nature. Two of the bankers questioned the ability of the company to grow as whilst it was fairly well established, it only employed 14 people. A key issue for all the bank managers would then become serviceability or the ability of the company to repay and service its debt. The existing outstanding debt, therefore, created a problem for them. As with all the cases visiting the premises was important. One banker commented on how this gave them a feel for the efficiency with which the business operated, taking signs such as the 'tidiness' of the premises as an indicator of how well run the business was. All the bankers stressed that it was the current nature of the operation that was important, if they could understand that, then it was more likely that they would treat a proposition favourably. One of the bankers indicated that they may want the company to take some initial measures before taking the proposition further. In this case there was some questioning of the outstanding debt and the current position of the company seeking further credit, the view being that some initial internal measures by the company's management may have to be taken before this could be taken further. In addition all the bank managers indicated that it would be dealt with at branch or 'local' level. Given the level of funding, one banker indicated that this would be credit-scored (rather than processed through a financial modelling system), implying that the bank manager would have to follow the credit scoring outcome. Only one interviewed banker recommended that the company should discuss their requirements with Business Gateway.
Overall Assessment
5.12 All the managers indicated that there was interest in taking this forward, but a number of issues with this case meant that further investigation would be required. The specific difficulty was the outstanding £300,000 debt compared to the level of turnover in the company and a need to understand the business and the nature of financing. The possibility of additional equity was raised, but some form of invoice discounting was the most likely outcome.
Comment
5.13 Although this case was relatively straight forward, it was apparent that the outstanding debt was a stumbling block for the bank managers, particularly in terms of understanding the nature of the business. The nature of trading history and the relationship with the company's local manager would have been crucial to taking it forward.
Actual Outcome The company applied to just one bank which was the local branch of the bank that they normally used. The application was turned down on the grounds that the business had too much debt (£300,000) as a result of funding previous extensions to the business and the difficulties of managing cash flow. The owner was told "there is nothing we can do for you anymore - don't ask us for money anymore". There was no issue with the business plan or with the business case presented by the company. The company also had sufficient trading record and their cash flow projections were sufficient to justify the application. The bank asked for a personal guarantee which the managing director considered to be too much. However, the company obtained £35,000 funding from equity investors within one week of being turned down by the bank which allowed the project to go ahead on a smaller scale. On the relationship between banks and SMEs generally, the managing director thinks the banks are very risk averse and that managers tend to be younger and less experienced than they used to be. Consequently, they are unable to use their discretion - "unless you tick the right boxes, you don't get anything". In general, the owner felt that the banks are not helpful to the success and growth of small businesses. |
CASE 3
NARRATIVE FUNDING REQUIRED: £100,000 to 'restart' the company PROFILE OF BUSINESS This is a metal fabricating company specialising in metal cutting including burr-free abrasive cut-off metal tubes, wires, rods, and related capabilities required to meet customers' tight tolerance and high-precision requirements. The company was established in 1995. It currently has a turnover of £490,000. The company's main activity is laser cutting and is experienced in manufacturing a broad range of customer specific, rapid turnaround parts from minute precision electrical components to robust automative parts. The company provides an innovative technology and high productivity by using laser cutting for an increasing number of applications in sheet metal processing. The company's competitiveness is based upon its high levels of production flexibility and the virtually unlimited diversity of materials and shapes that it is able to work in. The company employs 15 people, two of whom are working part time. It has pursued growth as a business objective for the last 2 years. The main factor constraining further growth of the company during the last 2 years has been a shortage of finance. The present owner is now aiming to re-structure the company in such a way as it can concentrate on better quality, higher value added work. This will provide the platform for the future growth of the business. THE NATURE OF THE BUSINESS CASE The company requires finance from the bank to help them restart the business by: - downsizing and
- focusing more on higher margin customers
Although competition in this industry is intense and increasing, the management believes that the project will increase turnover and result in a change in overall profitability of £50,000 representing a 10% change in the first year. |
Interviewed Bankers Assessment
5.14 This case created some difficulties for the bank managers as they saw it effectively as a downsizing within a competitive market and sector. A number of comments were made about the difficulty of understanding the nature of the case. Historical information would be required to understand the performance of the company. Three years historical trading figures on profit and loss and balance sheets would be required before the bank managers could take this forward. Although the case was categorised as a 're-start' in the information provided, managers interpreted this case as re-structuring to downsize the company. The managers considered that the company had a limited capital base, implying that security may be difficult. One banker considered that invoice discounting would be appropriate. A further difficulty for the bank managers was that two scenarios were involved in the case, one which was for the purchase of premises. If the purchase of premises was taken forward then one of the bankers commented that it would be necessary to bring in a more specialised retail team. Some of the bankers indicated a potential positive interpretation with an assumption that the company was progressive, innovative and seeking to focus on higher margin customers. All of them indicated that they would need to understand the management and the nature of the business, but indicated that if they could be satisfied about the more positive scenario, the proposal could be treated favourably.
5.15 In terms of additional information that the bank managers would require, this focussed on the trading record of the company and understanding the purpose of the proposed 're-start'. There were some differences of opinion expressed on whether the re-structuring could be a strength or a weakness. Some accepted that such a re-start or restructuring could be beneficial, especially in the sector which was seen as very competitive. There were comments by one banker that such re-structuring had been done with other companies in the sector to beneficial effect, particularly if it led to concentration on higher quality, more profitable products. As a result, the bank managers were interested to obtain additional information on the competitive edge that the company could offer. However, one banker thought the re-structuring was a potential weakness as the view was that the company could have difficulty in adjusting to the market quickly. All the bank managers wanted additional forecast or projected information for up to three years. The provision of this information may have some greater importance due to the nature of this particular case which was focused on a re-structuring of the company and a consequent change of strategy. Additional financial information would be required on debtors and creditors.
5.16 In this case, the company was predicting a loss of £30,000 in the first year projections. There was some difference of opinion between bank managers in how this would be treated. One saw it as perhaps being realistic but it was a problem with another, in as much that additional understanding of this would be required and the extent that it would affect serviceability.
Overall Assessment
5.17 This case may have been supported by some of the bank managers but the general view was that it was 'unconvincing'. Therefore, there was limited interest in taking it forward. The case was difficult for the managers to support as a new business customer, but as an existing customer they were more likely to fund the proposition and to understand the purpose of the credit facility. One banker commented that if it was a new customer, up to seven or eight meetings might be required before sufficient understanding was acquired and there was satisfaction with the purpose of the proposition.
Comment
5.18 There were some differences in opinion between the bank managers on the way that this case would be perceived and treated. Although the company was well established, it is likely that the proposition would be treated as relatively risky and not supported and they seemed to have difficulty accepting funding for a re-structuring case. The nature of the sector was a further factor affecting this case. It was unlikely that managers would be satisfied that the company could service the credit facility required.
Actual Outcome The company applied to just one bank for finance, which was not the bank that it had dealt with previously. Because the company was changing ownership, it was thought that they might obtain a better deal from a different bank. Although finance was not given to this company, the bank was satisfied with the business case presented. The managing director believed they had sufficient collateral, trading record and cash flow projections to justify the application. The bank gave the managing director the impression that they would finance the project, the local bank manager saying "yes we can do it", but it fell down in the end. The managing director believed that part of the reason for the refusal was that the bank did not understand their business. However, after a six month period of negotiation, the bank was prepared to give all the money requested to the MD personally. This delayed the project, but enabled it to go ahead completely. In terms of the relationship between banks and SMEs, the managing director believed that there was not enough personal contact between banks and small businesses. He also felt that contact persons at most banks do not have decision making power. Generally, he thought that the banks are not helpful to the success and growth of small businesses in relation to providing finance. He also felt that the analysis of funding applications is based too much on risk instead of potential gains and that banks should provide advice on financial planning. |
CASE 4
NARRATIVE F UNDING REQUIRED: £1million for a business acquisition which will enable new product and market development. PROFILE OF BUSINESS This is a manufacturing company which was established in 1997. The main business activities of the company are the manufacture and design of commercial vehicle glazing systems - mostly bus windows. There are three factory units in Scotland, plus satellite units in Cheshire, manufacturing windows and Halstead in Essex, manufacturing automatic doors for buses. The current turnover of the company is £4million. It employs 81 staff, including 5 in Essex and 16 in Cheshire. The management has been actively trying to grow the business during the last 2 years through two field/sight acquisitions. Growth remains a business objective of
the company for the next 12 months. For example, the door business in Essex is expected to grow since it is in a product/market area in which there is limited competition. The main factor constraining sales performance in this company is foreign competition, including competition in the glazing market from Eastern Europe, Turkey and India. NATURE OF BUSINESS CASE New products The company seeks money from the bank in order to help them to buy-out an existing door manufacturer for commercial vehicles, representing a new product line for the firm and an opportunity to diversify into a
complementary activity to their existing commercial glazing business. The commercial vehicle automatic door industry is a much higher value added activity than glazing. Commercial windows sell at under £100 per unit, whilst the automatic doors are worth £1000 per unit, plus there is the added value of the servicing and maintenance contracts. The proposed new product will be a complementary activity to the existing business activities. The company already has a strong customer base comprising commercial vehicle manufacturer and service providers. The
company's customers consist of large industrial or commercial customers and large repeat customers. They include major manufacturers such as Optare in Leeds, which is the third largest bus manufacturer in the UK
(very secure blue chip firm). The company also services all their customer service providers such as Stagecoach, Arriva, London Transport etc. Whilst the commercial vehicle glazing market is under threat from increasing competition, the commercial vehicle door market is less competitive, particularly within the UK and there is a clear niche for the company to
exploit. The company will be able to take over a considerable share of the market and design and manufacture a high quantity product, which is better and cheaper than their competitors for the UK market. The new products will be distinctive from those of their competitors and will be UK designed and built. The potential market is considered to be huge and the company has very good relations with UK's major commercial vehicle manufacturers. Therefore they are aware that there is a requirement for a new door
manufacturer and they know what product is required. They are able to supply the best quality product at less cost than their competitors and yet maintain reasonable margins. The main competitor in the UK is Dean and Peters Door systems, based in Beverley (East Yorks) and Braintree (Essex). They are the only large-scale competitor in the UK. They have three competitors in Europe, one of
which is Ventura, a Dutch firm that they have a good working relationship with. Ventura have now recognised that this company is a growing player in the UK market and the company have offered to buy a 25% of their
firm. There are on-going discussions. The MD's background is that he has vast experience of the market. He previously worked in the industry as the Operations Director for a Swedish firm operating in the UK market, prior to setting up this business ten years ago. Buy-out The opportunity for the buy-out came up quickly. With 10 years in the industry, the management has come to realise in recent years that there is an opportunity to diversify their activities into door design and manufacture and know that there would be much more service support attached to this high value added activity. The company had wanted to get into this market, but did not have the hands-on expertise. The opportunity to buy into this through acquisition is just what they are looking for, but it is an opportunistic situation. To carry out the evaluation of the proposal, the company ran a full financial analysis, undertook full due diligence, and presented sales scenarios for 3 years, demonstrating that it will be a very good acquisition. During the first year of the door manufacturing venture the company has a target turnover of £400,000 which would just about enable it to breakeven at the end of year 1. However, in year two sales will increase to circa £1 million and in year three they expect to increase sales to circa £1.5 million. Thereafter, it will probably even out at around that level. |
Interviewed Bankers' Assessment
5.19 As mentioned in the introduction to the chapter, this case provided a narrative only, without additional financial information being given to the researchers. The discussion of this case, therefore, focused on the extent of interest, the process if taken forward and the additional information required. The case was relatively attractive to the bank managers, allowing for the form in which it was presented. The company was well established and with over 80 employers and several operating sites, represented a medium-sized business with a turnover of over £4 million. The nature of the operation of the company was also relatively attractive, importing materials and providing relatively high value-added through their specialisation in the commercial vehicle market. However, there was some concern expressed by the interviewed bank managers on the extent to which the company may be over dependent on certain large companies (for example, Stagecoach) for a significant amount of their sales, who may subsequently switch to alternative suppliers. However, the nature of the repeat business that was involved was seen as a strength. This concern was taken forward by one of the bank managers, who considered that it would be necessary to bring in industry specialists from the bank, 'at an early stage' to obtain the additional knowledge that would be required to understand the niche sector of the company. Another bank manager considered that it would be necessary to involve Management Buy-Out ( MBO)/Management Buy-In ( MBI) investment specialists from the bank or an acquisition finance team, given that the funding was required for an acquisition. Some of the bank managers were relatively keen on taking the proposition forward; one banker was 'most positive about this one' and another considered that it 'looks a goer'. Other bankers were more cautious with the standard view that they needed to understand 'what is going on in the business'.
5.20 All the bank managers, however, were interested enough to judge that they would like to pursue an interest in the case. In taking this forward, given the nature of the business, the funding required and the stated purpose, all of them commented that a 'due diligence' process would be required with a business plan. They would need to satisfy that the debt would be serviceable. Financial modelling would be completed with the banks' computer-based modelling systems, which, as indicated before, would produce a guide to the risk and category of the proposition which would assist the decision-making of the bank manager. As in other cases, visiting the company's management and the premises would be essential. One banker considered that, dependent on the location, the case may be more appropriate for a more locally-based bank manager to take forward, say for example in the West of Scotland rather than the East of Scotland. The local manager would know the business, would have built up a relationship and would have taken it forward.
Overall Assessment
5.21 All the interviewed bank managers were sufficiently interested to take this case forward in terms of their own internal due diligence and protocol procedures. This would be obtained through an understanding of the financial structure of the company and through an expectation for a business plan. It may be worth noting that in this case the company's owner/managers indicated that a full business plan had been prepared, but were reluctant to supply this to the research team. The banks' internal financial modelling would be applied which would produce a risk and 'strength' result. One of the banks indicated that there were potentially a large number of categories that could be produced indicating the quality and riskiness of a proposition. All of the managers were relatively confident that this proposition could be taken forward, with perhaps additional specialists from the bank being brought in to aid the decision-making process.
Comment
5.22 Given the size and well-established nature of the company with its 'blue chip' customers and the credit facility required at £1 million, it was clear that all the banks were prepared to spend some time with the company to carry out their own due diligence and modelling processes. They would want to work closely with the company and were prepared to bring in specialist members of the bank to assist in the decision-making process. In addition, there was noticeably less concern with trying to understand further the purpose of the credit facility, there being more acceptance of the logic of the strategy of the company compared to some of the other cases. This seemed more appealing as a result to the managers.
Actual Outcome The company applied to just the one bank which was the one it normally used. The presentation of the business plan, full financials with 3 year projections and due diligence reports on the intended acquisition went well and the company was given every indication by the local bank manager that they would be able to raise the finance. However, the application had to be referred to the bank's central committee who eventually decided to reject the application, just two days before the time period for the acquisition was up. A single reason was given for the application being turned down, this being that the company was too exposed, being dependent on just three main customers. This was very frustrating for the company, since this situation had been stated from the outset and had not been considered as a major stumbling block in the earlier discussions. The managing director considered the bank to be risk averse. It proved to be an expensive experience, given the amount of time and money that was invested in this proposal and it would have been helpful if a quicker
response had been received from the bank and if they had flagged up the problems with over reliance on 3 main customers at an earlier stage in the process. By the time that they received the bank's response, it was too late for them to do anything further and the opportunity for the acquisition was lost. They felt badly let down by their bank and the problems seemed to
come from the bank's central committee. The managing director thought there are too many middle men in the bank finance system. They had to pay a lot of money to go down the process of trying to raise finance from their bank i.e. by providing full accounts and due diligence work - all of which represents a huge burden, particularly when the process is ultimately unsuccessful. He also felt that there is insufficient support for manufacturing and a lot of manufacturers would really benefit from assistance with purchasing new machinery in order to improve their systems. Too many established
manufacturers are making do with old machinery because the cost of new machinery is prohibitively expensive and there is not enough support for them to obtain the finance to facilitate this. Soft/lower cost loans would help, as this would help these manufacturers to become more competitive. |
CASE 5
NARRATIVE FUNDING REQUIRED : £450,000 for new product and capital investment PROFILE OF BUSINESS The firm was established in 2003 to sell hand crafted items, mainly Scottish handicrafts. The company employs 6 people, including the two directors. It has a turnover of £120,000. The management has been trying actively to grow the business during the last 2 years and growth remains the objective for the next 12 months. The main factor constraining sales performance is the fact that the company is in a rural location, so they have to advertise in order to develop trade. NATURE OF BUSINESS CASE New product The company wants to build a 550 sq feet building to hold a larger gallery and craft centre (3x current gallery size), plus a restaurant with 80 covers. The restaurant represents a new service and they plan to lease this out at £30,000 per year, plus a share of profits if takings go above £300,000 per year. They have an existing well establish restaurateur on board, who has a good banking track record. The new restaurant site is highly complementary to their art/craft/gallery business. It would attract even more people onto the site, as they can advertise restaurant services on the site as well and attract a wider range of customers. It will also be very attractive to tourists. The owners have undertaken a huge amount of market research, attending trade exhibitions, reading trade journals and also checking out similar types of facilities in the US and UK-wide. The management is well aware of what it takes to succeed in this market and what other 'competitors' are doing. The company intends to offer high quality restaurant service and a wide range of catering, from tea and cakes, to lunches and dinners and even corporate catering function which are what the customers are looking for. Main competitors do not really exist, they are UK wide in terms of other galleries and crafts shops. Because of their Scottish crafts bias, they are mainly in competition with Scottish galleries in more tourist related areas such as the Highlands and Western Isles. Although there is UK wide competition, there is not really much competition locally for the company as they are pioneers of arts and crafts in Aberdeenshire and also in tourism in the area, which is really underserved up until now for tourism activities. Capital investment The main reason for seeking to borrow money is to undertake the £600,000 building development required to house the new enlarged gallery, craft shop and restaurant. Potentially, the company can increase the range of their service offer, through diversification activities and a wider range of craft work display. This should provide more interest to a wider range of local and tourist customers and even specialist crafts buyers. The company believes that the project will increase profit margins from 25% to closer to 35%. |
Interviewed Bankers' Assessment
5.23 This case was of interest to the interviewed bankers and 'worth exploring', but there were a number of issues that caused concern. The case involved a small company in a rural location seeking to undertake a relatively large scale project. The location and the rural environment caused a number of concerns. Although several of the bankers were comfortable that garden centres could be profitable, citing known examples and, therefore, comfortable with the sector, the nature of the rural market 'was a problem'. Rural businesses have limited and dispersed local markets, unless there are any facilities that may attract seasonal tourist demand. Two bankers, from different banks, mentioned the example of the development of the 'House of Bruar' on the main A90 road north of Pitlochry, as an example of a very successful rural business enjoying trade 'all year round'. Thus, the notion that a good quality facility could be provided to attract additional trade in a rural location that could be successful was accepted, however, there were concerns to understand the nature of the rural location. For example, one of the bankers was concerned to understand what rurality meant in the context of the company; that is, the extent to which the business enjoyed passing trade, as would be the case with the House of Bruar, or was it more isolated and difficult to get to. Seasonality was mentioned by some of the bankers, but this was less of a concern than what were perceived to be limited local markets and the possibility of relative 'isolation'. The nature of the location was also associated with issues with the need for additional marketing. Given the small size of the company with just six employees, questions were raised as to whether the company would possess sufficient marketing expertise to attract the additional trade which would achieve the required growth in the business. Therefore, a further concern was the relatively ambitious plans of the company compared to its current size, seeking a £450,000 credit facility with turnover of £120,000. However, the logic and strategy of seeking to build a restaurant facility was accepted as a strength by all the bank managers. Other strengths included that the directors were relatively experienced and the restaurant facility would be leased to a separate company rather than run by current directors. Bank managers were also comfortable with the business seeking growth in the garden centre sector. The proposition involved the directors providing additional finance, which was seen as a further strength. The larger nature of the credit facility requirement compared to the investment of the bankers was not considered to be an issue.
5.24 In terms of protocols and processes in taking the case forward, the bankers expressed a need to understand and clarify the rationale for the £450,000 funding requirement and also to understand the nature of the business, particularly addressing some of the 'rurality' and 'locational' concerns discussed above. The standard previous three years' trading accounts would be required for profit and loss and balance sheets, showing how profitable the business is on the current levels of turnover. There was some concern with understanding the nature of the business and management strategy, more in terms of what the company was trying to achieve in the nature of the business, with some discussion of whether they were focused on 'garden' or 'craft' products. One of the bankers expressed a need to meet and understand the key staff/directors. Given the nature of this case and the size of the facility, financial modelling would be required and one banker mentioned that additional sensitivity analysis would be required. One banker considered that a full business plan would be required. If taken forward, because of the nature of the proposition, the bankers discussed the need to get forward valuations of the proposed 'restaurant' facility. This would require separate quantity surveying costings and an independent valuation of the facility from their panel of approved valuers. All bankers stressed the need to satisfy serviceability requirements before taking security, but valuations would be required for security in this case. In terms of the nature of projections, the initial forecasted losses were not perceived to be a major concern, so long as eventual profitability could be demonstrated and that the debt was serviceable. Given that the company was relatively recently established, it was considered that the Small Firms' Loan Guarantee Scheme might be applicable. One banker commented that they would need to clarify eligibility with the Department for Business, Enterprise and Regulatory Reform. One banker also commented that the relative complexity of the tax position for the directors meant that they would need to seek advice from a specialist tax accountant.
5.25 The case would be dealt with by a local business manager who would be familiar with the company.
Overall Assessment
5.26 A clear difficulty for all the bankers in this case was the rural location of the business and concerns that the market would be limited. The possible relative isolation of the business may have been a constraining factor. This apart, the bankers expressed a sympathetic attitude to the proposed strategy of providing a relatively high quality facility as an attraction for additional customers. They would need to understand the nature of 'how this would work' and the nature of the business, but the concept of leasing to a specialist restaurateur was attractive.
Comment
5.27 In principle, this case was attractive to the bankers, even though the size of the credit facility was high compared to the existing operation and turnover size of the company. The nature of the proposition to create a facility, which would provide security, with investment by the directors was attractive. As an existing customer the local bank manager would know the business and, more important, know the local market and have sufficient local knowledge to make decisions on what was viable. It appears that this would be critical in whether this proposition would be taken forward.
Actual Outcome The company considered a number of funding sources including making approaches to four banks. All the providers appeared keen to lend to the company, but were concerned about lack of trading records and collateral. The first bank approached offered finance, but it was not enough for the project to go ahead. The company had to shop around and obtained sufficient funding to meet their £450,000 borrowing requirement from another bank within the timescale. The lending bank was persuaded by the company's plans to lease out the restaurant to a restaurateur who was already a good customer of the bank. The bank required 130% of guarantee which was secured against the company's property. The director of the company felt they learned a lot from the process, which was understandably stringent. Despite obtaining the requested funding from one of the banks, the director also criticised the banks for being very conservative and being quite slow in offering finance. The director also felt that the amount of security required for the loan at 130%, was very high and this could have put many prospective borrowers off. He thought that banks in Aberdeenshire did not have any understanding or demonstrate any support for a tourism/craft related business - as they do not come across these type of businesses in this region. They actually sought finance from banks in a neighbouring tourist region, as they had more understanding of the sector that they are working in. Apart from providing finance, the director of this company thought banks could be quicker to assess applications and explain to potential business borrowers how they can improve their applications. This could avoid creating lengthy delays in the process. Perhaps more should be requested up-front in order to facilitate this process. |
Conclusions from the Case Analysis
5.28 A number of key conclusions can be drawn from the interviewed bank managers assessments of the five case studies put before them:
- All cases would involve meeting the management team and visiting premises, although with the small companies, this would be by the local business or relationship manager. The purpose would be to seek a better understanding of the business and of the management team.
- The management team, strategy and purpose seemed to be equally as important as financial analysis.
- Financial analysis would be prepared with a view to undertaking financial modelling analysis which would produce a guide outcome and category, although all the banks seemed to indicate that there was some discretion as to whether the bank managers' were required to follow the modelling outcomes.
- All the banks segment the SME market, the larger companies would have been dealt with by 'corporate' bank managers, smaller by local or 'business' bank managers.
- Three of the cases (cases 1 to 3), provided scenarios that were difficult to support for varying reasons by the bank managers. This was caused by a combination of financial and strategic management issues. The sector and location were additional issues.
- Two of the cases (cases 4 and 5) were likely to be supported and of most interest to the bank managers. However, in both there were potential factors that may have resulted in the decision not to take the case forward. In case 5 the rural location seemed to be particularly important as a limiting factor.
- Case 4 (involving an acquisition that would enable new product and market development) was treated most favourably in terms of interest, however, a full business plan would be required and due diligence to satisfy the banks' internal processes.
- There is little clear evidence of any market failure in SMEs access to bank finance from this analysis of what were five of the most promising cases for bank finance resulting from the business survey. Even if there were some issues with financial performance and track record, the banks would try to engineer a solution for existing business and existing bank customers, There was also evidence that the banks would attempt to pull together a 'funding package'. However, this would be more difficult for a new to business bank customer.
- The case analysis indicated that potential difficulties for SMEs in accessing bank finance could still exist in the following circumstances:
- For small businesses in a rural location seeking growth.
- For SMEs in perceived 'competitive' sectors, especially in manufacturing, that could not satisfy bank internal modelling and computer-based processes.
- For SMEs seeking growth through R&D and NPD, especially where it is difficult for banks to get the required degree of 'comfort' through security.
- For well established SMEs seeking a radical change/re-structuring with limited security.
5.29 With the interviewed bank managers' analysis of the five specific cases in mind, the next chapter is concerned with a more general discussion of the issues relating to funding SMEs from the perspective of the eight interviewed bankers.
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