It’s the age old adage heard from small business owners and CEOs alike. Anyone who has managed a business in transition understands, sometimes all too well, how rapidly liquidity dries up, even when it seemed so readily available only months or even days before.
Traditional lenders, consistent with their mandate, provide low risk capital in exchange for a modest return. As part of the bargain they are the first to be repaid in the event things go wrong - modest return for modest risk. This is the job of a financier - done well by lending money in volume and by not losing it. Hence the focus on very stable, profitable companies. It’s clear to see when sales and profitability are up, lenders are lining up. When things are down, they are not. It’s easy to get agitated about the perceived injustice of it all, but it helps to remember that deposit taking institutions are primarily investing the money from our savings accounts, so some prudence is appropriate.
Taking the banks appetite for risk into account, it doesn’t take much deterioration in performance to move a company into the "un-bankable" category. What often follows is a reduction of credit, leading to a downward spiral. The traditional lenders tolerance for various forms of risk and their institutional constraints often govern these actions leaving limited room to manoeuvre.
Luckily, the UK and other European credit markets are maturing and gradually catching up with the sophistication of the credit markets in North America. The bond market, direct lending funds and insurers are all becoming more active across the capital structure, which is a boost to the vitality and diversity of credit options for potential borrowers.
The direct lending funds, including alternative credit providers, often focus on working with companies which are not best served by the traditional lender. Businesses in transition may find the options provided by these institutions much more suitable to their needs. A tailored structure is often necessary, blending some elements of debt and equity in a customized product. Whilst larger firms and PE-backed companies are often more familiar with this territory, awareness is increasing among mid-sized businesses as well.
It is essential for potential borrowers to have a degree of awareness as to why the alternative lenders are comfortable when others are not, how they are funded and their expectations of return. It may be that the lender has a greater understanding of the value of assets, specialist sector expertise, or an appetite for equity risk. A clear understanding of these dynamics will help set expectations for the new relationship, which could make all the difference, giving management a chance to succeed.
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