The UK mid-market has experienced such powerful growth over the last five years that it’s now edging slightly ahead of Germany’s Mittelstand. But where is the funding for growth coming from and how has finding finance changed? Seven business leaders join IoD director general Simon Walker to discuss
Director general, IoD
Managing director, GE Capital UK structured finance team
Lending leader, GE Capital
Chairman, John Mills Limited
CEO, Tyrrells Crisps
Managing director, Xtrac
Chief operating officer, Track24
CEO, UK & Western Europe, Gett UK
SIMON WALKER Mid-sized companies are a vital but sometimes overlooked source of Britain’s economic strength. We hear a lot about the German Mittelstand, the companies dotted around Germany, which power their economy, but actually, similar-sized companies in Britain are performing just as well, if not better.
Between them, mid-market businesses in Britain employ nearly 10 million people, and turned over more than £1.5trn in revenue last year. And they’re on the march, with two-thirds reporting revenue growth according to GE’s own 2015 CapEx barometer. But, sandwiched between small businesses and large companies and multinationals, they have a unique set of requirements and nowhere is that clearer than in access to finance.
The space between small and large companies has a bewildering array of options, from private equity and mezzanine finance, to peer-to-peer lending, crowdfunding and invoice financing.
Over the last 10 years there’s been an explosion in the different sources of finance business can access and British firms are making the most of these new opportunities. In a survey of IoD members at the end of last year, a third said they’d used some sort of alternative finance over the past three years. In total, three-quarters of all alternative finance in Europe goes to British companies.
With that array of options I’d like to gather your thoughts on these issues and ask what opportunities and challenges you can see on the horizon and how getting the right mix of funding is crucial to businesses of all sizes. But first, over to Ian for his perspective from GE.
IAN WILKINS I think the last 18 months have seen some fairly significant changes in the market. Our research and our interaction with our clients shows an increase in confidence in mid-market companies. But also, there does now seem to be an increasing acknowledgement of the range of finance available to those businesses.
Traditionally, there has been an over-reliance on high-street banks and the traditional forms of working capital and finance in the UK. We’re certainly starting to see a very significant change in the willingness of businesses to look outside that traditional supply chain for their finance, be that alternative lenders, fintech businesses or asset-based lending. It’s great to see those customers are thinking outside the box and looking at alternative forms of finance for their business.
WALKER What have been your experiences? John, your business has probably been going the longest…
JOHN MILLS Initially we had a very good relationship with the high-street banks and they provided most of the finance. This all went sour for us, and for lots of other people, in the 2000s, and since then we’ve relied on a variety of different sources of finance. We’re wary of relying just on one because of the really bad experience we had with the particular bank we were dealing with at the time.
We use a variety, nearly all asset-based lending of one sort or another, invoice discounting, trade finance, asset finance of our 150 vehicles, mortgage finance for buildings we own, different sorts.
Having a spread has served us well. We’ve no outside shareholders – shares are owned by people who work at JML, so we’re dependent on outside finance quite substantially. Most of the purchases are done in the Far East and we’re financing a six-month stock cycle, so we do need a fair bit of financial support to survive.
However, we haven’t had enormous difficulty in finding it and finance has never stopped us doing what we wanted to do or thought was the right thing to do. It’s been difficult but not impossible.
REMO GERBER We’re five years old and there are challenges when you grow very fast. But equally the revenue side always lags behind, so we depend heavily on venture capital. Seed capital, early-stage funding, is quite available, but as the numbers get bigger it gets harder.
In terms of the classical funding mechanisms, yes, some of it becomes more available as you grow, but equally the banks are certainly still shunning fast-growth, young businesses.
Over time, credit ratings improve, but initially your credit ratings look pretty poor, so methods such as invoice financing aren’t yet really available. So you’ve got to compensate for that.
DAVID MILNER At Tyrrells we’re private equity backed, and there have been two private equity groups over the last seven years. I’ve been employed five years and we’ve grown around 30 per cent every year. We own all our own manufacturing. We’ve got four factories and this year we’ve spent just over £4m on those and next year we’re spending £10m.
We’ve never had any issue with accessing capital. When we discuss the requirement to either automate a factory or build a new one, we look at how much it will cost, how quickly it’s going to pay back, and if it’s 18 months or less then we’re happy. The least of my issues is getting capital to expand.
ADAM JOHNSON I arrived at GE before the onset of the financial crisis so I’ve seen the market re-adjustment through and come out the other side. My sense, from both the market and a GE perspective, is twofold. I think the whole dynamics of the marketplace have shifted: new private entrants in the marketplace, debt funds, private equity, challenger banks.
Importantly, we have evidenced an increased uptake of corporate asset-based lending (ABL)] facilities from larger mid-market and corporate companies. Traditionally it was the low end of the mid-market, but over the last few years larger businesses, multinationals even, up to £2bn-£3bn turnover businesses are using ABL as core working capital financing. This is quite a dramatic shift in the marketplace and I think there is a lot more to come.
MARIUS GILMORE At Track24 the business was run rather cautiously in the beginning; we started off as a service business, so the need for cash wasn’t great. We used to get a lot of cash early on from our customers through commitment.
It was never really run on debt. We’re at an interesting stage where we’re turning into a technology provider. So we have our own software engineers and we package our own product, so the pressure is on more than ever before – mainly because of payroll and the infrastructure we’re having to set around that, but we’re still servicing that out of our revenue. However, up until now it’s not really been a problem for us.
PETER DIGBY I led a management buyout in March and we had to raise funds. We went to the normal banks and they were falling over themselves to lend money on very favourable terms. We’re in engineering, employ a lot of apprentices and graduates and export 70 per cent of what we make. So I think we are in that sweet spot.
MILNER People usually like successful businesses because there’s lower risk. If businesses aren’t doing terribly well and they’re a higher risk, it is very difficult. It’s a more polarised lending market now.
WALKER Can I ask our GE colleagues, is it more polarised? Is it a choice between clearly successful companies, which attract rapid backing, and the rest of the community that gets left a long way behind?
WILKINS There’s an element of that. The reality is though, even for businesses that find themselves in a turnaround situation, there are a number of lenders in that turnaround space, whether it’s from an equity or debt perspective – there are lots of funds that operate in that part of the market. The obvious gap, I believe, is in the availability of smaller ticket private equity funding for smaller, younger businesses that require sizeable amounts of funding but have insufficient assets to secure that borrowing.
But for businesses in a turnaround situation and for the rapidly growing businesses, there’s going to be a broader range of financing options and as has been mentioned, the price of this funding is at an all-time low. You’ve got very low interest rates and the margins that the companies are paying on top of those interest rates are also at very low levels. In terms of the range available and the price, I believe that there’s never been a better time to obtain funding.
GILMORE One of the challenges we found a few years ago was, as a UK-based business with most of our contracts overseas, it’s very difficult to articulate the type of security those contracts offer, because most of them are with agencies working in Afghanistan and Iraq – which seemed to clear out the market immediately. We weren’t getting the right offers but we knew the business had more potential.
WALKER What’s going to happen when interest rates start to rise? Is that something that concerns you?
JOHNSON The interest rate environment has been relatively benign, and I think the outlook is still relatively benign. Everyone around this table seems to be benefiting from surplus liquidity in the market, with pension funds and insurance funds investing in alternative asset classes, whereas previously they weren’t.
As soon as there is a meaningful move in interest rates, or a market event, the dynamics of the financial services sector will change once again. Short term, and for me that’s anything up to three, four years, I don’t see a dramatic change, certainly not in domestic or European interest rates. There is freely available capital in the market for the majority of businesses at this time.
MILLS We had some negotiations with a private equity company – they were going to have a slice of the shares and loan at a relatively high interest rate.
The total cost in interest terms on this was about 20 per cent, so it was a no-brainer to turn down really expensive money like that, compared to borrowing on an ABL basis, which we could do relatively easily and on a sustainable basis. Obviously you want some headroom to make sure that you’re secure, but as long as you’ve got that and you’ve got a profit record to support it, I don’t think it’s that difficult to borrow reasonably large sums of money relatively easily in this country.
DIGBY If you’re a successful business, that is. It’s certainly what we found. You turn up with all the paperwork the bank want. I read that 40 per cent of SMEs give up after the first stage because they go to the bank and they discover how much paperwork they need to supply and think it’s too complicated.
JOHNSON What we’re talking about here is the different types of businesses, their capital structure and the sources of capital they can access – so smaller start-ups, SMEs, clearly their source of capital is going to be more restricted than something like John’s business or Tyrrells. So it all depends on where you sit in the capital structure and the perception of risk versus reward. You have to strike the right balance.
WALKER There’s a different gap there though, isn’t there, between the start-ups and you, with your track records of success. What advice do you have for the bright kid who’s started up a pizza business and it’s turned into a chain of half a dozen? Where does he get his money from?
MILLS I don’t think he’d have a problem getting the money if he’s running the business profitably. The problem tends to lie with companies that aren’t very well run and aren’t profitable, who claim they’re going to be profitable in two or three years’ time, but they’ve got big losses in the meantime.
GERBER One of the reasons we managed to access very large sums of capital was that we have a very good business plan. Don’t over- or underestimate and make sure you create a bit of a track record over time. Obviously the sums grow bigger and what the VCs are looking at is whether there is a management team there that knows what they’re doing and can go and execute it. But there’s no point in having a business plan which is going to be £100m, when you can’t hit £2m – obviously you’d lose credibility. Be ambitious, but then be able to go from that. That’s the advice I’d give.
WALKER For those of you who are backed by private equity, what took you down the private equity track, as opposed to the asset-based lending one?
GERBER No assets! We grow at 300 per cent per year and that conversation is fundamentally different to that of a business with an established track record over 20, 30 years and a really good trading history. At the very beginning you’re selling an idea. There’s absolutely nothing besides the idea. Then you start building a track record and selling growth, but you need to back up these results over time.
WALKER GE, would you say there’s no point business leaders going to people like you if you have a bright idea but no assets?
WILKINS Our core business is focused on asset- based lending (ABL) – by definition we’re lending to businesses that have the assets to secure the funding that we’re putting in place. I think one of the interesting developments over the last four years has been an increase in collaboration between private equity firms and the ABL market.
Businesses are now using private equity to fund the part of the cash requirements that they don’t have an asset base to support, but will then leverage the assets within the balance sheet to provide extra liquidity, potentially at a lower cost than the private equity. This is a fantastic balance of these two products.
Confidence in the mid-market is also critical. In 2006/2007, businesses were leveraged incredibly highly, and there was so much liquidity in the market that banks were falling over themselves to provide funding. Businesses had a huge level of confidence and therefore borrowed significant amounts of money. It’s been very different since [the crash]. Businesses have taken a far more cautious approach to investment in capital equipment, acquisitions and entering new markets.
That caution isn’t surprising as there’s never really been a clear 12-month period for businesses without some major event that they want to see play
out, whether it’s the general election or the eurozone crisis.
However, it does feel now that there is perhaps a slightly clearer landscape for businesses and that we are starting to see an increase in confidence. Fingers crossed, we’re through that period of inertia where businesses have been waiting to see what happens and that people will now make those investment decisions.
MILLS One quite important factor across all the countries we operate in, not just the UK, is that start-ups have to pay much higher rates of interest and endure more onerous terms on guarantees. There is a barrier there. Just because interest rates are based on very low base rates, doesn’t mean that actual borrowing takes place – especially for small companies with poor track records – at low rates of interest.
WALKER This is a very interesting area and it’s an important one for the IoD. We have a network, the IoD 99, which is aimed at young entrepreneurs. It’s attracted an enormously interested crowd with hopes and ambitions, but that’s all they’ve got. What are your messages to people in those categories, both in terms of access to finance and in terms of spreading their businesses? And do you have a message for government, which tries to stimulate businesses like this through things such as the Seed Enterprise Investment Scheme?
MILLS Make a profit every year. That’s so important when you start a business. If you’re starting a business which is going to make profits in four or five years’ time but huge losses in the early days, then it’s much more difficult to finance it.
If I was advising anybody starting a business I’d say structure your business so that you get into profitability right from the beginning if you can. Or if not, then early on, because then you’re going to be able to develop the track record which will enable you to borrow the money you need to expand.
DIGBY I think the government needs to grow the Enterprise Investment Scheme and certainly work with the banks to put forward some degree of protection so that some of this risk can be mitigated.
Even though there are obvious tax incentives, if you want people to get involved then it’s what we’re talking about all the time – it’s risk and reward, it’s no different. Small companies have to give 20 per cent returns to private equity investors because they are high risk, so you’ve somehow got to try to reduce some of that risk.
JOHNSON If you’ve got a good idea, then my advice to businesses starting up is to network extremely well. If you have got the right idea then, in today’s market, capital will find its way to you. Part of the problem is that the really small start-ups go to one source for their financing, their domestic bankers.
They might not have any credibility or track record, so they could be turned down or find cost of financing prohibitively expensive. If they had a wider network, they could tap into different pools of capital, whether it’s venture, private equity, alternative debt etc. Provided you have a viable concept then the outcome might be different.
MILNER Small businesses are frequently in need of capital but they often need help too, and if you pick the right private equity house, with the expertise that aligns with your requirements, then that can be incredibly helpful. I’ve worked with three of them and yes, they provide the money, but they also have experience in areas that you might not.
DIGBY Your comment about making a profit is good. They can’t always do it but a good friend of mine once said that when you start a new business, just think to yourself “What are you going to invoice on Friday?” – because that’s the gist of it. If you’re not invoicing something on Friday then who’s going to pay your bills? It’s very easy to carry on doing a lot of work and just pedalling to stay where you are.
GERBER Fail fast – that’s my advice. Not necessarily the whole business, but if you try different ideas, get to market quickly – don’t over-engineer and rack up a lot of costs. It’s right to have a plan towards profitability, but is it right to be profitable in year one? Probably not, and if you look at some of the most successful businesses in the world, they have not been profitable from day one, but they certainly had a plan. There are very few businesses that have actually made the really big pay-off in the end that have been very unprofitable in the early stages.
GILMORE Speaking as a technology company, there’s a preponderance for engineers to get everything absolutely perfect. Testing models and theories are great, but getting a prototype and proving the concept in a small market is vital. It was vital to our own success; we started with one customer and six subscriptions but focused on that, made profit and then grew from there.
SIMON Walker Thank you all. Ian, can I hand over to you to wrap up?