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Crunch Time for Business Buyers


Only if you've been living with an uncontacted Amazonian tribe could you be unaware that something called a credit crunch is going on.

And yet a year ago few people had heard of such a thing, while the era of steady growth and easy credit had lasted so long we'd come to take it for granted.

Our complacency has been shattered now, that's for sure.
Barely a day passes without fresh reports on the havoc wrought by the credit crisis. As the lending market has atrophied house prices - that supreme barometer of middle-class self-worth - and retail sales have tumbled, resulting in the credit squeeze encroaching well beyond the business pages.

In comparison small-business finance has received negligible coverage in the mainstream media.

So, is it any harder to raise funds to start, buy or grow a business?

Henry Edjelbaum, a finance broker for ASC Finance for Business, says this isn't easy to ascertain.

"If you're buying or starting a business the statistics aren't as easily available as with residential mortgages, for which you'd go to the land registry. It's more about anecdotal evidence than pure statistics."

We've spoken to a number of finance brokers - who seek out funding and broker deals on behalf of entrepreneurs and small businesses - and a bank to gather such anecdotal evidence and to try and form a coherent picture.

What exactly is a credit crunch?

A credit crunch occurs when there is a substantial reduction in the supply of credit, causing loans to become more difficult and expensive (ie, entailing bigger deposits and interest rates) to obtain.

Previous credit crunches have tended to be short-term events, like the market blockages that followed the 9/11 terrorist attacks in 2001 and the bursting of the dotcom bubble in 2002.

The current crisis, which is proving more durable, began in the US last summer when low-income households were given mortgages they couldn't afford to repay. When many began defaulting on these 'sub-prime' mortgages the shockwaves were felt around the world as the debts were sold on to various lenders and investors.

With so much bad debt sloshing around the global financial system banks grew nervous and started hoarding their cash. The reduction in credit supply has contributed to and been exacerbated by the accompanying economic slowdown.

How much is this affecting small business and, in particular, would-be business buyers?

Sarah Busby, a finance broker for Birchwood Business Finance, is unequivocal about how difficult it has been getting funding for her clients:

"Brokers are having to work two or three times harder to get deals through. I've had two or three lenders recently where they've put out offers and then tried to backtrack."

For all the lack of measurables one thing is abundantly clear: the number and variety of providers has dwindled. And one type of lender in particular is vanishing from the market.

End of easy money

"A lot of the specialist lenders - the likes of Commercial First, Base Commercial, Salt Commercial - have pulled out the lending market," says Busby.

The specialists she refers to include non-status lenders, which grant loans without delving into the borrower's income or credit history. Although such lenders offered worse 'loans-to-value' - the percentage of the business price they finance - and higher interest rates, they at least gave people with chequered income or credit histories the chance to get into business.

"It's now a lot harder for people who are self-employed and don't have any proof of accounts," says Kevin Shaduwa, a broker at Face2Face.

And, he adds, there's no sign that entrepreneurs are deterred by the austere conditions, so roughly the same number of would-be borrowers are chasing less credit.

"We've been having the same enquiries as before," he insists. "But it's now more difficult to find a provider for every single case."

With less credit available lenders are obviously fussier about who they lend to.

"The lenders are cherry-picking those with good security," says Shaduwa. "Ie, if we lend this person any money and their circumstances go wrong, can the lender get his money back?

"And number two is serviceability: can the applicant service the loan - have they got more money coming in than going out?

"And the third one is credit history. Whereas before there were a number of lenders which would do mild adverse credit - small defaults, misspayment, etc - they are very difficult to get through now without a big deposit.

More information

Sarah Busby insists that, despite the worst lending conditions since the early 1990s, "lenders are still very keen to lend."

"But they are now laying down the rules as to what they will or won't look at.

"The underwriting and risk assessment is a lot tighter. They're looking at incomes more closely to ensure serviceability."

Henry Edjelbaum, a broker for ASC Finance for Business, agrees that lenders are now "demanding far more information".

"Six months ago, if you were to buy a guest house, banks were quite happy to ask about the profit for the year. Today they would want the seasonal cash flow and analyse how you manage the low and high season.

"It's far more detailed."

Larger deposits

They're also demanding more in the way of a deposit it would seem, especially from first-time buyers.

"Purely because they are stricter on the serviceability requirements," explains Busby. "Often people can't raise those sorts of deposit - they are large amounts to find.

"Once they get on the property market it's fine. It's making that first step - proving that you're capable of paying the debt back."

Busby says that banks aren't "lending the same, high loans-to-value that they were a year ago. Before, 75-80% was quite common; now many lenders are only lending 75% of property value as opposed to going-concern value" - the value of the company as an operating venture, meaning it includes the value of intangibles such as goodwill and intellectual property.

It's doubly difficult for homeowners hoping to leverage the value of their property in the deal.

"You've also got properties downvaluing now," says Busby, "so people don't have as much equity in their properties as this time last year so they can't raise as much for a deposit."

Lennox Simpson-Gray of Simpson Gray Associates thinks banks are reluctant to lend money for leaseholds. "And if they do, it's very expensive," he adds.

Busby reckons "you really need freehold security - either buying a freehold business or offering your house as additional security to get the funding you want."

Simpson-Gray estimates that "banks are looking for a deposit of one third or more."

Shaduwa notes that "before, someone with a 20% deposit might have found a lender to look at it sympathetically if they perhaps had other security or relative experience, ie, same job to same job."

Stupid lending

Now, he says, banks are generally more insistent on relevant experience. "If you've got an astronaut who wants to open a restaurant," he says, "we've got a problem."

But is it such a bad thing that an astronaut can't open a restaurant? Could the credit squeeze save people from themselves?

"What people call the credit squeeze you could also call the end of stupid lending," says Henry Edjelbaum. "In the Evening Standard there was a story about a secretary who was saved by the credit crunch because she would otherwise have taken on a mortgage and lost her savings."

"For sensible deals there are sensible providers out there. We can even finance speculative property development still - if it's the right deal."

Shaduwa also thinks credit is readily available if you meet certain, reasonable criteria.

"Any bank is going to lend £150k for a £500k property to a guy who's been doing it 20 years and has a clean credit history. There'll always be money for those types of people."

Might the credit crunch at least encourage entrepreneurs to plan more carefully - to take more care over picking an industry and a business, calculating the figures and so on?

Unfortunately, there is evidence that sensible borrowing has been blocked, as Paul Evans of LT Finance can attest. He's struggling to find finance for one client even though he has adequate security, already runs successful businesses and is only asking to borrow 70% of the bank's valuation.

"Rates definitely higher"

Sarah Busby has noticed an increase in interest rates on offer.

"It's very rare now to get a customer getting a deal below 2% over bank base from a new lender, whereas before there were lenders happy to go as low as 1.5%. The rates are definitely higher."

Even banks' "existing clients have seen interest go up," says Edjelbaum.

John Davies, marketing director of Barclays Local Business, is predictably upbeat about Barclays' fortunes but does acknowledge the new market constraints.
"In a world where it's becoming more challenging to find money, we see ourselves as very fortunate because we are still in a position where we are keen to grow our lending book at all levels, both large secured and smaller unsecured loans."

Perhaps their optimism is well placed: one corporate adviser says that although "certain banks are stuffed, others are absolutely open for business." With less competition, however, the remaining banks are imposing more swingeing terms on their customers.

Banks often reject applications out of ignorance, according to Paul Evans, particularly for a sector like the licensed trade, where, although the industry as a whole is struggling, many pubs are still goldmines.
"If a bank manager is given a memorandum about pubs, it would be a black and white situation: 'sorry I can't help you'. Unless he's very commercially minded - and you don't get a lot of those in the bank industry."

How to improve your chances

Pick a low-risk sector

Evans, a former pub landlord, concedes that banks "hate pubs at the moment."

So are banks generally favouring businesses in markets with low failure rates over riskier propositions?
"There's no evidence of it but I'm sure they are," he speculates.

Edjelbaum thinks that it's harder to get finance "across the board. There was always a higher risk with certain businesses."

Kevin Shaduwa has also noticed "providers shying away from pubs," as well as "petrol stations, anything polluting the environment, new-build flats…"

However, "if you've got very low loan-to-values on solid bricks and mortar," he adds, "the lenders tend to be more than happy. So if you're a hairdresser in a 500k property wanting to borrow 150k and everything else fits, they'll be more than happy.

"I don't think it's so much about the sectors - it's about good quality security."

Sarah Busby says that "every sector is being hit to some degree, but some are worse than others."

A market that "is still pretty healthy" is "the residential investment market, purely because first-time buyers can't get into the property market so they're turning to rented properties instead.

"But again, the loans-to-value has even reduced on residential investment. People are having to put down greater deposits - but if they're still able to do that they're still investing soundly as far as I'm concerned."

Regardless of which sectors the banks are wary of, pick one you're experienced in or at least do your homework on it and they'll be much more pliable.
Buy a business

"Buying a business is now a shrewd way into business ownership," according to Edjelbaum.

Busby agrees:

"Lenders are minimising their risk and a start-up venture is obviously classed as very high risk because it's all speculative income.

"What I would recommend is maybe to not consider startups unless they're 100% pressing the right buttons. Maybe go for an established business where they can actually see the track record of the business and where you've got a steady income from the word go.

"I think start-ups will find it tough this year."

However, Kevin Shaduwa thinks "somebody purchasing with no experience will have more problems than somebody starting a business with the relevant experience, good security, good serviceability and a good credit history."

Get your business plan right

Banks have had their fingers burnt giving money away too easily and they're resolved not to repeat their mistake.

Entrepreneurs need to reassure them that they'll get their money back and the best kind of reassurance is a cogent business plan with a comprehensive set of figures.

"Passion and energy is one thing - but you need a good business plan," says Edjelbaum. "Anybody buying or starting a business in today's market conditions requires a far greater level of planning.

"Failing to plan is planning to fail."

Getting your figures right, says Shaduwa, is paramount.

"Always keep as little borrowing against the security as possible.

"Make sure cash flow's right and look after your expenditure, because the lenders are frightened and want six months' business and personal bank statements. And look after the credit files."

But it's no good having perfect figures if they don't bear any comparison to reality, says Edjelbaum.

"We had a classic case. A guy wanted to open up a restaurant and all the figures were perfect.

"The only thing he needed to do was to turn his tables three times in an evening - but it wasn't going to happen.

"It has to be realistic as well. It's not just about telling them what they want to hear."

One anonymous corporate finance adviser encapsulates the challenge perfectly:

"How well a business markets itself to a bank, which has always been important, now matters more than ever."

Use a finance broker

The credit squeeze is leading a growing number of entrepreneurs to recruit finance brokers to this end.

"It is a tough market at the moment," says Busby. "Many people who used to pop along to their high-street bank now find that they now need someone in tune with the commercial market to find out if an application is viable or if they are completely wasting their time."

Busby advises people against "parting with any upfront fees until brokers can show that they've done their homework and can produce at least offers of intent from lenders - because the market is very changeable at the moment."

Even if you've had a great relationship with the same bank for years, says Edjelbaum, they might no longer be able to meet your needs.

"It just cannot be assumed that relationships with banks will remain unaffected by the credit crunch," he insists.

It's still worth speaking to a broker, he adds, and one "who has been through a credit crunch before, one which has thorough market knowledge and experience."

You can find a finance broker to suit you on the Services Directory.

Build your relationship with your existing bank

Although it's worth shopping around, maintaining your relationship with your current bank can be worthwhile. If you're a known quantity, then you're a safer investment.

"I wouldn't necessarily advocate changing your bank and throwing away 20 or 30 years of a relationship," says Steve Currie of Catalyst Corporate Finance. "On the other hand, certain banks out there have more money than others and will be more competitive in the current environment."

Consider other types of finance

Edjelbaum thinks that although "interest rates and deposit demands are higher, you've got more alternative business finance methods. It's not all property-based - you have invoice discounting, factoring, asset finance, leasing..."

With lenders suspicious of people without adequate assets to use as security, the government has widened access to its Small Loans Guarantee Scheme. The scheme offers affordable, security-free loans guaranteed by the government.

"They've lifted the five-year trading limit which means most companies are eligible now," says Paul Evans. "Before April, if the company had traded longer than five years they weren't eligible."

Edjelbaum, however, thinks the scheme could do more to bridge the huge gap in business finance.
"Has it been used as a tool to help? No. It's a very long-winded process.

"It's unfortunate, because as a concept it's brilliant."

Grants are another option, although few businesses have the credentials.

"It's a bit of a minefield trying to track them down - you can chase your tail," says Evans.

"There are a lot to do with the greener side of things - reducing carbon emissions, energy-saving things, things like that - disabilities, anything promoting the community, but not a vast amount for small businesses."

Busby says it's always worth speaking to business angels, wealthy individuals who provide often quite substantial investment in return for equity in the company.

Should buyers bide their time?

No one knows for how long the aftershocks of the credit crunch will reverberate around the financial system.

The International Monetary Fund recently warned that the problem will get worse before it gets better.

"I'm hoping it will be a shortlived, mini recession and that we'll bounce back in a year to 18 months time," says Busby.

"But it always takes the market a bit to recover from these things."

If we assume that it'll be over in 18 months time - and we can't - are there grounds for prospective buyers waiting until the storm blows over?

"It depends on the business," says Paul Evans. "I'd have to look at if it's a viable business, what impact the current situation is going to have - whether there would be a reduction in sales or if you could face the weather and get through it.

"If it were property-based I'd say hold on a minute as prices are going down.

"But," he adds, "if you've got cash in your pocket that's in your favour - you could perhaps negotiate a better price now."

However, Busby says that, unlike residential prices, "the market is still relatively holding its own. But again, that could change another three months down the line - we just don't know.

"People are being a lot more cautious about what they're investing in. They're taking out smaller loans than they were two years ago, which is sensible.

"What we advise people to do is to borrow in accordance with your earnings."

And that's advice that will stand you in good stead whatever the economic weather.

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