Why should SMEs consider an alternative to bank finance?
In the aftermath of the global financial crisis that has seen trillions of dollars wiped off the value of assets, and many banks liquidated or nationalised, many banks left standing remain under severe financial distress, for the following key reasons:
- Impaired assets
- Weakened capital
- Tougher capital adequacy rules
- Reduced investor confidence, and
- Sluggish economic growth.
These reasons will reduce banks' capacity to lend to businesses and will increase their operational costs. To offset these constraints, banks are likely to raise their lending interest rates and their associated fees. Businesses will ultimately pay more for less.
Banks are unlikely to recover for several years.
There is an alternative for small businesses to raise essential finance – corporate bonds.
Corporate bonds have been used for decades by big borrowers (such as Tesco, BP, and Centrica) and big institutional investors (such as pension funds, sovereign wealth funds, and investment companies) as an alternative to bank loans. The amounts borrowed and invested at a time can easily be in the hundreds of millions, and for up to 100 years.
Small business corporate bonds apply the same concepts of corporate bonds issued by the big players, but on a smaller scale. The amounts raised per bond range from £2m to £10m+ and they mature in 3 to 7+ years.
Unlike bank loans where the money comes from a single bank, with corporate bonds the money comes from many individual investors. Many are small retail investors, investing as little as £500 and multiples of £100. Others are high net worth and sophisticated individual investors, or institutional and professional investors.
A corporate bond can be either secured over specific assets (such as buildings, machinery, invoices, loans and other assets) or unsecured. The bonds can rank ahead of all other obligations of the borrower or be subordinated. Maintaining adequate asset cover and quality will reassure investors and enhance the business's credibility and ability to obtain further finance from investors in subsequent bonds.
The interest rate paid is often fixed rate or a margin over a reference rate such as Base or LIBOR.
Most bonds are paid in full at their final maturity, or they may be redeemed earlier at the option of either the bondholder or the issuer.
A Trustee acting independently of the coordinator, would be appointed to represent the interests of investors, providing further assurance to investors and lowering their risk, which will benefit the business also. A standby servicer can be appointed, to step in if there is a major default, take over operations to wind down the company and realise cash to pay bondholders. A registrar will be needed to maintain details of bondholders and to pay periodic interest to them. A receiving agent handles the initial application processing. A valuer might be needed to value assets securing the bonds. Accountants might be needed for due diligence (such as checking and preparing financial statements) or to audit annual accounts. IT specialists can set up a website to attract online applications and to provide details electronically instead of print.
It is not essential for SMEs to target investor networks to issue corporate bonds. They can be issued directly to retail investors generally, i.e., publicly. This direct route will avoid private investor network fees and might involve lower arrangement fees, but they will probably incur additional costs, such as marketing, and possibly fees to intermediaries such as stock brokers, to distribute the bonds to retail investors.
Direct SME retail bonds should not be confused with retail bonds that have recently been issued by large companies and banks, such as Tesco, Lloyds TSB, and RBS. The latter retail bonds are listed on a stock exchange and subject to complex and expensive documentation (a Prospectus approved by the UKLA). They are therefore relatively more expensive to issue than direct retail bonds. They have also been relatively large transactions (tens of £millions). They are in essence standard corporate bonds that big companies have been issuing for decades and have used to raise £billions from institutional investors in capital markets.
Direct SME retail bonds are genuinely suited for SMEs because the documentation is simpler, the transaction size is small, denominations are small, and listing is unnecessary. Costs can be much lower too.
This form of finance can be in the form of debt or equity. It is raised from sophisticated and high net worth private investors rather than retail investors because it is of higher risk. Why is it of higher risk? Because it is used by SMEs that are in financial distress, who are close to insolvency or administration. The debt is an urgent injection of funding to keep the SME afloat and to give it breathing space to effect a turnaround.
To see if your business can raise finance by issuing corporate bonds, of if you wish to take advantage of the other benefits of membership, or if you are looking for urgent turnaround financing, then email ACF to request a free and no-obligation discussion, or call 07800 862499.
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Applied Corporate Finance (ACF) is not authorised by the Financial Services Authority. In relation to FSMA (2000) and subsequent revisions, this communication does not constitute: arranging a transaction in investments, making arrangements with a view to transactions in investments, a financial promotion, or an inducement or invitation to engage in a controlled activity or investment. ACF is not authorised to give investment advice. If an organisation applies for specific financing, such financing will, where necessary, be arranged by or with the approval of, a person or firm that is authorised by the Financial Services Authority