Time to look beyond the banks

Time was when funding a business began and ended at the bank. About the only upside of the banking crisis is that there are now more alternative sources of finance available, and, equally important, a greater propensity for businesses to use them.

In his capacity as manager of banking relations and growth capital at Enterprise Ireland, the State's business development agency, Donnchadh Cullinan has a bird's eye view of the transformation that has taken place with regards to SME finance.

“EI supports exporting companies with a turnover of €1 million plus and 10-plus people, anything from food to technology, at every stage of development, from university spin-outs to the Glanbias of this world. My team’s job is to make sure there is an appropriate funding environment for all of them. But what’s appropriate for a software start-up is going to be different than for an established company with plenty of assets, so the key for each business is to establish ‘What is appropriate for us’,” says Cullinan.

It could be bank debt, it could be investor capital or it could be monies raised from alternative sources of finance. It’s increasingly likely to be a blend of all three.

That’s because business reliance on bank lending here was sorely in need of correction. According to ISME, the small and medium business lobby group, in Europe, only 30 per cent of small businesses depend solely on bank finance. In Ireland, the figure is closer to 70 per cent and, by some estimates, even higher.

Part of the problem is that raising finance is not a subject business owners have traditionally been strong on. “Entrepreneurs are typically very good at the making side of building a business, are weaker on the selling side, and find the funding challenging,” says Cullinan.

“At Enterprise Ireland we don’t care about the ‘widget’ or the ‘revs’. We want you to tell us why someone will buy it. Similarly, when it comes to securing finance or funding, businesses don’t always come prepared with an investor-value proposition.”

When it comes to finding, and paying for, the right kind of finance, this homework is required. “For example, a venture capitalist will expect a certain return, perhaps from three to 10 times their investment. A bank will take a lower rate of return, but will expect a lower risk proposition too. Entrepreneurs need to know what the investor-value proposition is. But too often, what we see is the sales deck with a couple of finance slides tacked on at the back. That’s not good enough.”

During the banking crisis, over-reliance on bank debt emerged as a major problem, particularly as so much of that debt was secured against property. “We ended up with companies that were profitable, good businesses but with bad balance sheets and big property ‘overhangs’,” says Cullinan.

To help plug emerging funding gaps, EI launched its Development Capital Scheme, seeding the ground for the advent of private equity funds such as MML Capital (worth €125 million), BDO Development Capital (€75 million) and the Cardinal Carlyle Ireland Fund (€290 million).

Typically, these funds provide equity funding of between €2 million and €10 million, to mid-sized, export-oriented businesses, particularly manufacturing and technology companies in traditional sectors including engineering, food, life sciences, services and electronics, “adding another string to SMEs’ bow”, says Cullinan. “Ironically, the massive challenge was getting people to use it.”

To many – particularly family businesses – the mere idea of relinquishing equity was anathema. “Very many said ‘We’re going back to the banks instead’,” says Cullinan. What they found, however, was that the banks, which themselves learned lessons from the crisis, are no longer keen on backing projects that are 100 per cent dependent on bank debt.

“It’s only now that we are seeing entrepreneurs recognising that the days of 100 per cent senior debt are gone,” he says.

Not all deal spaces are equally well served, however, with competition greatest for big-ticket deals of between €2 million and €10 million, but less so for SMEs looking for between €750,000 and €2 million.

‘Get creative’

Consequently, SMEs requiring these amounts are having to “get creative”, he says, including making better use of EI’s angel investment infrastructure.

The growth of trade finance and the advent of crowd-based funding initiatives are also changing the funding landscape. Banks will continue to play a central role for SME finance, he points out. But while their appetite to lend is increasing, it is the “safer stuff” they are looking to back. “How you present yourself to your bank is therefore key, again it’s about knowing your investor value proposition,” he says.

This is all the more so given the work of the Strategic Banking Corporation of Ireland (SBCI), the Government-backed dedicated SME company whose funds are distributed – at a discount – through the pillar banks. As of last July, it had lent €350 million to SMEs.

It is also channelling money to SMEs through non-bank lenders. In 2015, the SBCI and Finance Ireland, the country's biggest non-bank lender, announced €50 million in new funding for small businesses. Last year, the Ireland Strategic Investment Fund announced plans to invest €30 million in equity into Finance Ireland. In all, Finance Ireland is estimated to have provided in excess of €300 million in new lending to Irish customers by the end of last year.

The lessons learned about business funding during the recession will not be lightly cast away either.

“What the recession did to many small businesses was make them switch from expansion mode to one where every euro was held hostage. If you are in a mode where you don’t have access to capital, opportunities are lost and you are more risk averse,” says David O’Kelly, partner in KPMG’s corporate finance practice.

“We are now in a more buoyant time but we can see that the people who have done very well are those that had access to capital.”

For SMEs looking to secure access to finance today, education about the expanded menu of options open to them is vital. “In the past, SMEs were used to having banks look after all their financial requirements,” says Ray Murphy, sales director First Auto Ireland Finance, a provider of lease finance and a division of Finance Ireland.

“Now there is recognition of the need to have other providers too, to look after areas such as asset finance, while letting the banks look after your cash flow needs. Above all, SMEs need options.”

Pick your partner carefully

"Pick a lender that doesn't just suit your needs now but one likely to suit your needs in the future too," advises David O'Kelly, corporate finance partner at KPMG.

With all funders, pick your partner carefully. “Know what you want and prepare for getting it. That way you are going to funders with a prepared requirement which is the best way to end up getting the funding you want, not what suits the funder. And ask yourself, ‘Will this party be able to provide funding over time?’ You don’t want to be changing funders every couple of years, because it’s costly and time-consuming.”

Banks remain the predominant providers of finance here, but educate yourself on the alternatives. “There is still some resistance to relinquishing equity, for example, but that is reducing,” says O’Kelly.

“The fact is, some investments are more appropriate for debt and some for equity. Remember, if you are having a tough time with a bank, it may indeed be that the bank is not getting what you are saying, or it may be that it is not in a position to back you. In such cases, consider equity. The State has done a good job seeding a private equity sector here, UK firms have come in behind it and there is a lot of global money sitting in private equity funds right now that is in need of a home.”