One of the most pervasive impacts of the global financial crisis on the business community has been the sudden evaporation of debt funding.
Over the past decade debt funding became relatively easy to obtain, as banks competed with each other to increase their share of the business market. Having bricks and mortar security was not required and cash flow lending became commonplace and simple to raise. Invoice financing was offered by major lenders in user-friendly and non-disclosed forms, allowing businesses to fund growth on the security of their invoices alone without the stigma of the old factoring arrangements. If a business was viable, then funding could almost always be found, usually from the major banks. The need to recourse to non-bank lenders became quite rare.
All that is now a thing of the past – the money supply has dried up and the banks no longer seem interested in the size of their share of the SME market.
The major banks may say they are still ‘open for business’ but they are very selective in regard to the business they are open for. Bricks and mortar security again seems to be a prerequisite for new lending. Cash flow lending is mostly off the menu and at least one major bank has ceased invoice financing.
While the banks are still happy to finance residential property, businesses are being strangled for funds. Take the ridiculous situation where a long-established, consistently profitable business was declined funding while, shortly after, the same bank gave the owner a very substantial loan to buy a new home. The servicing of the home loan is from salaries and dividends from the business – the same source as the business loan would have been funded from.
These are the sort of decisions that leave business people tearing their hair in frustration – decisions that have little to do with rationality and much to do with broad directives from the upper echelons of the banks - directives as to what types of funding and industries are credit worthy, sometimes carving out whole sectors, such as property development, despite the quality of individual deals.
Of course we have seen all of this before. In the early 1990s banks reigned in facilities and black-listed certain industries. (Back then we also saw a lot of foreclosures which, thankfully, does not yet seem to be as prevalent this time – the banks appear to be more content to wait for recovery than they were then.)
What happens when an opportunity arises in a market is that, inevitably, someone sees it and moves to take advantage of it. This happened in the early 1990s when non-bank lenders and smaller banks moved to take up many of the good deals that the large banks would not touch. Hopefully we will see this happen again but it doesn’t appear that it will be anytime soon.
No doubt we will also see businesses turn to equity funding – with private equity filling the gap that the withdrawal of debt funding has left. External equity funding has been unnecessary for a large proportion of private businesses in recent years as banks have been more relaxed in their attitude to gearing and interest cover ratios.
While private equity funding is expensive and often intrusive, it may now be the only option that many businesses will have to fund growth – especially by strategic acquisition. However many private equity players are still licking their wounds and have not yet sufficiently recovered to venture back into the market. Indeed their high leverage model may not be able to be replicated until the market unlearns it lesson again.
In any event, some businesses will choose not to grow if it requires them to take on an equity partner. This may be because of the desire of many business owners to be free of outside interference and not to be locked into an exit that an equity investor would require. Family businesses in particular have traditionally shunned equity funding, preferring not to grow if that was the only way of achieving it. With the plentiful cash that the banks made available in recent years, most sound businesses were able to fund their growth from debt and were relieved of the need to choose between growth and an equity partner.
There is no doubt that what we are now experiencing is not just a downturn in business but also a loss of opportunities – from start-ups that can’t get started, markets that can’t be exploited and products that can’t be developed to established family businesses that won’t grow because their raison d’être precludes them from accepting the terms of equity investors.
Who knows what potential profits will never be made, how many jobs will never be created, and how many innovative products and services will never get to market because of the dearth of debt funding?
That is the real tragedy. While we wring out hands over falling share prices, failing businesses and the rise in unemployment, what is really heartbreaking about this global financial crisis is that it has, at least for a while, stolen some of our future.