Asset finance: Making the most of an untapped source of capital
Discover where the untapped sources of cash in your company are
I don’t think we could have done it without asset finance,” recalls Nigel Barratt, managing director of West Country baked products manufacturer Furniss Ltd. Barratt led a management buy-in of Furniss at the beginning of 2004 after its parent company went into receivership.
But while the investors managed to raise sufficient cash to make the purchase, there was a shortfall when it came to the working capital required to turn it into a going concern. “Stock levels had been run down when the company was in receivership,” says Barratt. “We estimated that we had a working capital requirement of between £500,000 to £600,000 for the first year.”
With no more equity finance available and the banks unwilling to advance that kind of sum via an overdraft facility or conventional term loan, the buy-in team focused on the company’s assets as a means of raising the necessary cash. And with an annual turnover in the region of £5m, the company had a hugely valuable asset in the shape of its order book. So part of the solution to the company’s cash problem was an invoice discounting facility provided by City Invoice Finance. This enabled Furniss to draw down cash as soon as an invoice was raised, rather than waiting until the customer paid the bill. In addition, the company sold its machinery to a finance company (at about 70% of its value) and then leased it back. The invoice discounting arrangement instantly improved the company’s cashflow situation while the leaseback facility provided a lump sum. As a result, the company was given the breathing space it needed to turnaround its performance and earlier this year was in a position to acquire Sherriff Ltd, an Exeterbased rival.
As the experience of Furniss illustrates, unwillingness on the part of your friendly high street bank to extend your overdraft or offer a conventional loan does not necessarily mean the end of the road in terms of your ability to borrow. If your business has assets, you should be able to raise cash against them.
And asset finance doesn’t mean you have to own property or have a factory full of expensive machinery. Even if your company operates from rented offices and owns nothing more than a handful of rapidly depreciating PCs, a stapler or two and a cupboard full of stationery, a healthy order book may be the only asset you need to secure capital from a lender.
Asset-based lending is a growth area. In addition to the business units of high street banks, there are dozens of specialist finance houses. The deals on offer include facilities to borrow against receivable cash (invoice discounting and factoring), structured finance products secured against tangible assets and leasing arrangements that allow you to spread the cost of major equipment purchases. The upshot is that if the bank that likes to say ‘yes’ delivers an emphatic ‘no’, there are plenty of other players who may be more in tune with your business and willing to lend you what you need. So what are your options and where do you start?
Invoice discounting and factoring
It’s common for businesses like yours to suffer the cash implications of the gap between selling to a customer and the arrival of a cheque two or three months later. While you continue to spend on the wages, rent and supplies you need to fulfil the order, the client takes advantage of your generous credit terms or simply pays late. Result? A cashflow black hole. And as accountants never tire of telling us, the majority of business failures are caused not by poor sales but by unsustainable cashflow.
In these circumstances, it certainly makes sense to consider borrowing against your debtor’s book. After all, if sales are healthy a lender can be assured that you will be able to repay what you owe as the cash comes in. The loan might be in the form of an overdraft but an increasing number of companies are opting for the more flexible approach offered by either invoice discounting or factoring. Both of these solutions allow you to ‘draw down’ cash from a lender as soon as an invoice is sent to a customer. Typically lenders will advance a maximum of between 80% and 90% of each invoice. It’s not free money, of course, as the finance house will levy interest and a service charge but you benefit from the fact that money is paid into your bank account straight away. Provided you have the sales to underpin the borrowing, cashflow should no longer be a problem. For instance, Polythene Industries has been drawing on an invoice discounting facility arranged by finance house Eurofactor to address cashflow issues in the wake of a merger with another plastics company, Polyplast. “The downside is that you have to pay interest and service charges,” says MD David Rawle, “but the charges are small when compared with the benefits.”
As Ian Byers, corporate development director at Lloyds TSB points out, facilities that allow you to borrow against receivables are of particular interest to fast-growing businesses. Many of you will have experienced a situation where an upturn in sales means jam tomorrow but a real headache today in terms of additional costs. “But the value of factoring and invoice discounting facilities effectively grows with the company,” says Byers. “That means you don’t have to go back to the bank and negotiate new terms.”
But what if your order book falls? Well, you might find that the overdraft was a pretty good bet, after all. “Invoice discounting and factoring are really most effective for expanding businesses,” says Peter Ewen, a director of Venture Finance, a company that provides receivables finance and structured lending against tangible assets. “If the sales ledger takes a dive then the working capital will also fall.”
Spot the difference
While there is little difference between invoice discounting and factoring in terms of the cash you can borrow, they are by no means interchangeable options. For factoring you have to decide whether you are happy for your customers to be dealt with by the bank or factoring agency when it comes to credit control. Although the image of factoring is changing, it has been traditionally associated with companies that are in trouble.
“We were a little concerned about what our customers would think,” says Ian Williams, managing director of TG Can Technology, a supplier of precision machine tools to the packaging industry. When the company expanded into overseas markets – including China and South Africa – it secured an export factoring facility from finance company Bibby. Williams admits that some customers were concerned enough to ask whether the company was in trouble, but ultimately it wasn’t a serious problem. “We haven’t lost a single customer because of factoring,” assures Williams.
And according to Kate Sharp, chief executive of the Factors and Discounters Association (FDA), some businesses are happy to hand debt collection to a third party. “It’s seen as a means to outsource credit control,” she says.
Generally speaking, though, lenders tend to insist that companies they perceive as higher risk take the factoring route while more established businesses are given the confidential option of invoice discounting. Aside from any reputational issues, there are financial implications as service charges will be higher for factoring. Sharp says that while fees for invoice discounting tend to come in at around 1% of the total borrowed, the figures range from 1% to 3% for factoring. In addition, you will pay interest.
You can reduce costs by keeping your borrowing to a minimum. While a lender might offer you up to 90% of an invoice, you are not obliged to draw down that maximum percentage. “The bulk of our customers draw down an average of 50% of invoice value,” says Russell Warner, group commercial director of Eurofactor UK Limited. However, as Warner points out, there is flexibility built into the system. If you need more cash around, say, VAT payment time or in a cyclical downturn, you can borrow closer to your maximum.
And over time, you should be able to reduce your drawdown, even to the extent that you won’t need to borrow against receivables at all. “We expect our profitability to improve,” says Rawle. “Improved profitability will wash through to cash and we expect our invoice discounting drawdown to reduce.”
There are around 60 players in the UK market and not all factors and discounters are the same. All reputable lenders will want to have a close look at the quality of your order books, but some will be more sympathetic than others. For instance, TG Can Technology had to seek out a specialist that would finance exports and the management at Furniss talked to a number of invoice discounters before settling on City Invoice. Many specialist firms will be looking for established businesses with turnovers of one or two million plus. One key factor cited by entrepreneurs is the speed of decision making. How long does it take the provider to say yes or no? “Delays can be caused by poor bookkeeping or the complexity of a business. As a guide we advise prospective clients to allow up to 10 days to complete the transaction,” advises Mark O’Neil of invoice finance house IGF Group. The lesson – shop around.
If your business needs a lump sum rather than a facility to manage cashflow, then you may have to consider a term loan secured against the value of more tangible assets. This is more familiar territory for most of us but it isn’t something that will be available to everyone. As Ian Byers of Lloyds TSB Commercial Finance points out, some assets are more viable than others when it comes to persuading a bank to part with its cash. “Lenders are looking for assets with a clear value in the second hand market,” says Byers. “Traditionally that has meant equipment with wheels – cars, vans, trucks, forklifts – and items such as printing machinery.”
Sadly – given the prevalence of computer equipment in the 21st century workplace – many lenders aren’t so keen on anything to do with IT. Manufacturers and suppliers may charge you an arm and a leg for the latest high-speed, multigigabyte workstations, but as most of you know, the resale value of this type of equipment plummets almost as soon as the ink has dried on the cheque. This makes it a bad bet for banks, but some specialist providers may be able to help you.
Nor are lenders falling over themselves to lend against that other celebrated asset of the modern age – intellectual property (IP). You may have a hugely influential brand or the world rights to a miracle cure but the value of IP is just too tenuous to persuade lenders of its value as an asset. “A brand name might lose its value overnight,” says Byers. “It is very difficult for a lender to put a value on something like that.”
On the other hand, as Gerry Hoare, managing director of Enterprise Finance Europe (an invoice discounting and factoring specialist) points out, if you are licensing a brand, then you may well be able to borrow against the value of the licences.
Overall, the asset lending market is becoming more sophisticated and in addition to the tangibles, you may also be able to borrow on your current levels of cashflow, providing you can demonstrate it is sustainable. As with most business loans, the rates depend on circumstances, but according to Byers, they are currently coming in at around 1% to 1.2% over base, plus an arrangement fee.
It’s worth remembering that many of the finance companies offering factoring and invoice discounting also provide term loans against assets. If they are already advancing you money on the basis of your sales ledger they will have an intimate knowledge of just how successful your business is. The upside is, this may boost your chances of a positive decision when you ask for a different type of loan.
It could be that you are borrowing to buy equipment – at which point you should probably ask yourself the question, “why buy when I can lease?”.
Whether you’re in the market for IT hardware and software, cars or manufacturing machinery, leasing provides you with a means to spread the cost over a period of years while using the said equipment to earn money. So too does a term bank loan, of course, but depending on the nature of equipment, leasing may be more suitable. According to Craig Pickering, a consultant at the Finance and Leasing Association (FLA), there are times when outright ownership can be a millstone around your neck, particularly in the case of items that become outdated relatively quickly. “Businesses can hang onto their assets for too long,” he contends. “If you lease, the lessor can give you the option of upgrading.”
Because of almost instant value depreciation IT is a prime candidate for this kind of treatment, as are fleet cars. However, the leasing arrangements go beyond simply ensuring that your PCs can run the latest software or that your sales staff are driving this year’s model. As Kirstine Wilson, a director of Siemens Financial Services is keen to stress, technical support can also be built into the deal. “If you look at the example of IT equipment, the maintenance of hardware and software is important. To be credible in this market, leasing companies have to offer maintenance as part of the package,” she says.
As with factoring and invoice discounting, there is no shortage of players, ranging from banks to equipment suppliers (offering finance on their own products) and specialist boutiques. The terms available include lease-only finance (where ownership is never transferred) and hire purchase. Payment terms tend to coincide with the useful life of the asset.
As with a bank loan, the flipside of spreading the cost of the equipment over a period of years rather than paying outright is generally a premium on what would otherwise be the purchase price, but Wilson stresses that you have to look at the total cost of ownership, including any tax benefits that come from leasing and the cost of selling old equipment to upgrade. And, like Furniss, you can do clever things, such as selling equipment for a lump sum and then leasing it back, a deal facilitated by finance specialist Davenham.
Beneath the broad umbrella of asset-based finance, there are a great many options that can be utilised by your business at various times in its development.
TOO MUCH TOO SOON
When Sweeney Environmental Ltd was forced to turn down business that would have been worth ?3m it was time to act. Sales figures had risen from ?2m per annum to a current level of ?9m over its four year life and the strain of making ends meet began to show, particularly with profits being reinvested to grow further.
As a wholly-owned business with no outside investors, the company?s coffers were stretched by a ?2m investment in its plant. ?The finances were creaking,? group financial controller Stephen Green admits, ?and we got to the stage where we had to turn away a potentially valuable client.?
That was clearly an unacceptable situation, so armed with evidence of a growing sales ledger the company, which develops machinery to sort waste into component parts ready for recycling, set about looking for financial support and ultimately settled for an invoice discounting arrangement with Lloyds TSB Commercial Finance. Green says that with any facility based on loan against receivables, you have to convince the lender the business is worth backing. ?The lender has to find you a sexy, exciting prospect. They have to take an interest in the business.?
Lloyds TSB?s decision to back the company has given Sweeney Environmental breathing room to grow its revenues but Green does not believe that it will be a permanent arrangement. ?As profits rise, the less you need to draw on the facility,? he says.