Debt finance: a tried and tested opinionMike Lander, founder of Ensoul, an architectural and interior design company, and fellow Supper Club member, recalls his experience of debt finance: “Having borrowed over £7 million between 2007 and 2009, I know only too well the impact of having a bank looking over your shoulder every month, especially if you breach any of your loan covenants. “You can quickly find that what you thought was an arm’s length relationship with your bank – with you in complete control – turns into a situation where they have very real powers to force your hand.”
Debt finance and your SME: it’s personalBecause early-stage businesses are higher risk with generally fewer assets, they will often be asked for a personal guarantee from the owners and directors. This has deterred many because a personal guarantee merges your business and personal risk, meaning that should your business be unable to pay off the loan, your savings, real estate and even valuables are on the line.
Be aware of the risksThere are hidden threats to look out for like Material Adverse Change (MAC) – a contingency provision often found in venture finance contracts and lending agreements. It grants the lender a right to back out or call in debt in the instance of a “major adverse change” in the company or even the broader market. The good news for borrowers is that MACs can always be heavily negotiated and – because a material adverse change is notoriously difficult to establish – are not commonly used to default a borrower. Recent case law restricted their scope considerably, most significantly ruling that the burden of proof is on the lender to show that a MAC event has occurred. But the landscape is changing – fast. Challenger banks have prospered by breaking these conventions, offering different lending options and assessing risk by other factors like balance sheet, customer base, and growth potential.
How to reduce these risks
Matt Katz, head of corporate finance at Buzzacott, offers five tips for mitigating personal guarantees.
- “Banks will be more comfortable in waiving a personal guarantee if an entrepreneur is visibly investing themselves. But timing is crucial. Banks often ignore ‘historic’ investments, no matter how close to the loan application they were made.
- “Build a good track record before asking.
- “Rule out a personal guarantee agreement at the outset – this may restrict the pool of potential banks, but if you have a good business you are still likely to find a supportive bank.
- “Negotiate a limitation – hitherto a timescale (12 months for example), milestone (such as an agreed return) or size (a guarantee limited at £25,000 for instance, will put you ‘on the line’ but shouldn’t lose your house).”
Consider your lenderMainstream banks are unlikely to call upon the guarantees as long as you have “behaved” as an entrepreneur. Smaller banks and other lenders tend to enforce them more frequently whatever the circumstances.
P2PP2P lending has grown dramatically since the financial crisis and innovation is set to boost its uptake even further. Four years on from Santander’s landmark partnership with Funding Circle, peer-to-peer (P2P) lending is set to disrupt business lending further. Players have now gained full authorisation from the Financial Conduct Authority to offer innovative finance ISAs (IFISAs). IFISAs allow individuals to use some (or all) of their annual ISA investment allowance to lend funds through P2P lenders with tax-free interest and capital gains. These, it is predicted, could help unlock an estimated £80 billion in cash ISAs for small business growth.
Venture debtVenture debt is becoming increasingly popular. These loans are provided by specialist lenders to pre-profit SMEs with an established business model. Available earlier and in larger amounts than traditional bank loans, venture loans tend not to ask for personal guarantees. Silicon Valley Bank (SVB) was one of the first to accelerate venture debt to the mainstream for early-stage businesses. Other venture debt players include Boost & Co and BMS Finance – funded by the British Business Bank – and offer loan rates between 11-15%, depending on the risk of the business.
“UK banks don’t understand tech companies and they’re less tolerant of low or no profit. By contrast, Silicon Valley Bank gets tech companies and their growth potential”. – Steve Phillips, founder, Zappi.Boost & Co lends throughout Europe and favours industries such as software services, internet, life sciences, hardware, and cleantech, while BMS Finance lends in the UK and Ireland. Traditional banks are trying to disrupt the challengers. Santander Growth Capital Loans are available to UK businesses with a turnover between £2.5 and £50 million, and 20% growth, at a rate of 10% per year plus 10% fee at the end.
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