Corporate Finance Associates Blog

Following my earlier blog item relating to the fact that from the IoD’s figures nearly 60% of businesses have failed in their applications for funding , a new phenomenon is emerging, being that of organisations that promise the earth and rarely deliver, only after having parted the client with a significant amount of their cash!

Commonly known as Advance Fee Fraud this is where an unscrupulous broker (or claim to be a broker) promises access to an eye watering array of financial deals that really get the juices going, what with “advances up to 85% LTV” “rates from 1% above bank rate” “no credit checks” and so on, all of which are patently unrealistic in the current credit climate, but the downside is a significant upfront fee for the “broker” to go to work for you.  However a few weeks or months down the line they fail miserably, but the fees were “non- refundable”.

The National Association of Commercial Finance Brokers (NACFB) of which we are Full Members have been actively campaigning to stamp this out and welcome all reports of this sort of activity whether from their own members or those not affiliated with them, as the aim is to maintain the reputation of the brokers that don’t promise pie in the sky but will work diligently to get their clients the best deal available.

Commercial brokers are, for the time being anyway, able to operate in an area that is not covered by strict FSA regulation, the downside is that anyone could set up shop tomorrow and start trading with few skills or knowledge to bring to the table, apart from a tremendous ability to convince would be borrowers to part with large upfront fees.

Do we charge fees, most definitely, as it allows us access to lenders who would not normally pay us any introductory fee?  What we do achieve due to our “bulk” application approach, where we can introduce a much larger amount of business to a lender over time are slightly better terms than if he were to go to his bank direct, often covering our fees within the first year.  We also charge a proportion of that fee at the outset but that is a nominal amount just to cover our costs and not the £5,000, £10,000 and even £20,000 up front fees we have come across recently. 

We rely on our reputation and having been around for the last 20 years we still want to be here in 20 years time so our fee structure is geared to successfully delivering an offer on the basis we have already outlined with our clients.

Just remember, when it comes to wonderful deals, if it seems too good to be true, it probably is.

It appears, finally, that someone has woken up to the fact that the lenders bailed out by the UK Taxpayer are not delivering on their promises to support the SME sector with business borrowing.

I was tickled by a comment on the BBC news this morning (09/02/10) from a spokesman from Lloyds Bank claiming that they are not lending to businesses as much as they agreed because no one is applying to them.  This is wildly off the mark as our experience has proved to us with banks making it fairly difficult to submit any proposition with a better than even chance of getting past their underwriters.

I am old enough to remember when the local bank manager had authority to grant facilities and as they lived on the doorstep they had their finger on the pulse of how their branch interacted and supported their local business customers.  They understood businesses and worked with them to move forward.

Times changed as the business lending function was centralised and faceless individuals made all the decisions and the idea of the old “Bank Manager in the Cupboard” (Midland Bank ads back in the 70/80s) went out the window.  It was at least starting to revert to the local Business Development Manager (BDM) having a much more hands on approach to local lending, when the common complaint at the time was that these people just got to the point where they understood your business and they were moved on to greater things and you have to tell your story all over again to someone new.

Then came the Credit Crunch (as we have all decided to call it now) and gradually the banks slimmed down their BDM teams and took any small link between small business and the bank decision makers away as EVERY transaction now has a tortuous task through the underwriting process.

We have always aimed to answer these faceless underwriter’s questions before they even get to ask them and that does mean having to garner much more background information from the client than was ever needed in the past, and these decisions being made about supporting small business are being left to individuals who firstly have never ever run a business in their life (I have always thought it would be a good idea for bankers to be seconded to industry for a portion of their development to see how the other half functions) and rarely if ever would lose their roles by saying no to an application.  After all they are only “protecting the Bank’s shareholders”.  The skill is in saying yes, and this skill is not being exercised as often as it could be.

The claim is that they are indeed still lending but at what price?  Definitely higher margins of at least 200bp above previous norms, double the fees, 40 – 50% shorter terms, much lower LTV’s and it is only the very good companies that can live with these.

My argument is that providing serviceability can be assured with a reasonable amount of headroom and the applicant is clean and paid for, the lenders should be looking to do everything in their power to help and deliver on the commitments made to the Government when they were bailed out in the first place.  They are in the risk business after all, and the rewards are very good now.

It just reminds me of Mark Twain’s apt definition “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain”, well it has been raining but the sun is coming out again so let’s start sharing those umbrellas as promised.

When times get tougher (and sometimes even when they are not) ours and subsequently lenders’ suspicions are aroused when something obviously isn’t right with the proposition we are presented with.

It is to be expected therefore that we need to ensure that relevant checks are undertaken to ensure what we are seeing is the correct picture, indeed the Money Laundering Regulations (MLR) require that we are on top of our game in this regard.

All secured lenders are vulnerable in two key areas, defective valuations and fraud – although sometimes the fraud can be linked to the valuation. 

In most cases it is difficult to prove that a valuation is fraudulent as opposed to negligent. However, a common theme is that a non local valuer or one man band has been used to value the security property.

Lenders now insist that they instruct their own valuer and valuation report as it is the only way they can control the situation, and this is often backed up by their own due diligence methods including their local representative doing a “Drive by” assessment, Land Registry Searches (they only cost a few pounds after all), and reference to tools such as Google Earth.

Where the lender is asked to use an existing valuation as the basis for a new valuation, most, along with these additional checks, try to ensure that the valuer is local to the property.  Rewriting existing reports is a very grey area at the present time, most lenders don’t accept them and more and more, as valuers try to maximise their own fee income, they themselves won’t agree to undertake them.

The other area to be aware of is that most lenders have a point (not often advertised) at which they look for a supporting auditing valuation from another valuer.  Anomalies can often be found when these two opinions are then considered.

Ensuring that the borrower is who they say they are and that they have the ability to deal with the property is the other big challenge.

As part of the various Know Your Customer (KYC) processes we and the lender, require certified copies of the borrower’s UK Passport and two original, recent utility bills. These can then used to verify the borrower’s ID electronically.   Photocopies are NOT acceptable, and when we see them alarm bells can start ringing.  I remember a seminar put on by one of the main UK lenders where we were all shown very, very good copies indeed, of payslips, bank statements and utility bills, and they would fool a lot of people less diligent.  These were actual documents the lender had received in support of real Buy to Let applications.

The relationship between the borrower and their solicitor is also considered. Comfort is obtained where the solicitor confirms that they have acted for the borrower for a number of years. Conversely, if the borrower is unknown to the solicitor and/or the solicitor being used is not local to the borrower, then further investigation may be required.

All the above information is then considered in the context of the application.

An example from one of the lenders we work with attests that sometimes peculiarities leap out.  

“One such case was a borrower living in a scruffier part of Manchester buying a property in Holland Park and – here’s another suspicion raiser – using solicitors in Leicester!”

 “A quick check at HMLR revealed that the borrower’s residence was owned by his partner and a Companies House check on his alleged employer revealed there was no way – according to the accounts at least – that he could be earning his stated salary”.

Needless to say that application was quickly rejected. – Thankfully it wasn’t one of ours.

In order to prevent fraud, lenders are advised to verify the ID provided; ensure the valuers are local to the security property (and if not, ask why not) and establish the connection between the borrower and their solicitor.

Finally, and perhaps most importantly of all, there’s the “gut feeling” that comes from many years of experience and a general intuition that puts us on our guard.  Just questioning whether the reason for the loan makes sense in the first place, how it was introduced to us, if it will cost more to move than stay put,  what is the underlying reason, does the borrower, their stated income and occupation, their residence, the activity shown in their bank statements all tie up together?  After all, if these questions can’t be answered and the lender doesn’t have a clear understanding of who they are lending to and why, it is probable that the loan application will be turned down

Everything we do is encompassed in KYC, observance of MLR guidelines but underpinned by still treating our customers fairly, but if our help is required these areas have to be right.

We hear about green shoots of recovery and it is easy to get (or continue to be) complacent about the lifeblood of most businesses namely cashflow and in the fog of the Credit Crunch here are some financial faux pas to avoid

1. Tax Liabilities

it’s easy to get carried away and forget to build tax into your financial forecasts and budgeting. Use an accountant, they are less frightening than you imagine and can help you understand the need to budget for how much tax & NI you expect and will need to pay. A good one could save you the equivalent of their fees by their knowledge and actions too

2. Ignoring the Authorities

Even if you are setting up as a sole trader, you should notify the Revenue and Customs (HMRC) immediately. Penalties are payable if notice is not given within a certain timescale. The rules on financial penalties changed on 6 April 2009, so don’t be caught out by out of date advice. There will be more to consider if you are setting up a limited company, so make sure you get the right advice, again contact an accountant early in the life of your business.

3. Being too Cheap

Value yourself, your products and services. It can be hard for new businesses to compete on price as existing competitors may find it easier to undercut you, or have a larger client bank to work with. Try other ways of making your product or service attractive to new customers.  Why not offer a tiered service so that those expecting more from you are happy to pay more.  It has been said that an average business increasing their prices by 10% can afford to lose 25% of their customers (maybe those that give you the most grief) and still be as profitable as before.

4. Underestimating your Cash Needs
 
It’s often said that ‘Cash is King’, but it is so important it is worth re-iterating. Make sure you have sufficient levels of working capital. Many businesses fail, not because they are not profitable, but because they lack cash. The bank overdraft is not always the most effective way of achieving that especially if your business is growing.  Speak to us we may have a better alternative.

5. It will never happen to me

New businesses often rely entirely on one or two key people, and little thought is given to what would happen in the event of accident or illness. Plan for the unexpected and make use of insurance where appropriate. If you are a partner or a company director make sure you protect your business in the event of a partner or a co-director becoming ill or dying. Business protection can often be the first thing to go if things get tight, but the cost in the future will be massive by comparison.

6. Is Your Working Capital Working?

Even in the current low interest climate, there are reasonable returns to be had on your working capital. Keep the funds held in your current business account to a minimum and make sure you are maximising the interest payable on your deposit account. With many business deposit accounts paying very little interest and significantly better returns available elsewhere you could be missing out.

7. Get a Reality Check

When forecasting your sales levels, make sure you are realistic. Build in factors such as delays in payment – particularly where you are offering credit to customers, who themselves are experiencing their own challenges, and of course those inevitable bad debts.

8. Dismissing Contingency Planning

Every business should budget for a contingency fund. It could help get you out of a scrape, or more importantly provide valuable funds for a new business opportunity.  Think about Disaster Recovery too, what would happen if your IT systems fail, or your premises are burnt down or flood.  The right insurance will pay out but cannot compensate for your time and effort to get back to normal.

9. Being afraid of Financial Reports

It’s easy to be baffled by jargon, but reports such as your profit & loss account, sales forecast and cashflow analysis, should be an essential part of your day to day business, and are not difficult to understand.  Again talk to your accountant, who can get you past the jargon or alternatively take a part time course in Business Studies and Finance, they will all help.

10. Get Advice when you Need it

Never enter unknowingly into a contract – always get advice if you need it first. There’s a lot of general advice available free, and, like us many professionals offer a free initial consultation. If not, good advice often pays for itself. A good rule of thumb is that if you don’t pay for advice expect that advice to be flawed, and someone else’s opinion when they have no vested interest in your success is about as much value as a belly button.

Above just remember that doing nothing is a decision, and often represents a decision to fail as in business as in life in general we are either moving forward or falling backwards, never can we be certain to stay in one place, in other words as a mentor of mine once said, “You are either Green and Growing or Ripe and Ready to Rot”!

We are asked on a regular basis to arrange funding for those building developers out there that are still keen to get on with residential and commercial builds, but the reality comes as a shock to many of them, that despite the “supposed” masses of money the banks are lending they see none of it, and indeed are unlikely to, at least at anything near the terms that used to exist.

In the pre-Credit Crunch days there were two essential ways to finance a development project, go with a bank who would usually lend up to 65% of the land value and up to 65% of the build costs drawn down in stages as the development progressed, or secondly go with a specialist lender who would lend up to 60% of the Gross Developed Value (GDV),  often resulting in less input from the borrower and very often 100% of the build cost covered.

In the former case, it was great if you had the funds, most developers didn’t as their money was still tied up in the last development that was now being sold, in the latter case, these forward thinking lenders made development funding a much easier proposition.

Well we have the Credit Crunch, and a lot of the GDV lenders either closed their books (some of them having Icelandic parentage) or took a step back to see what the market would bring, and the high street banks just refused to sanction new deals at all, but would not announce to the marketplace that they no longer had an appetite for this sector.  Out of all this however there remains some specialists who still know what they are doing and can still help with the smaller projects.

We are now 2 years on and after the spate of large developers shedding completed stock, by bulk sales or heavy discounts, and closing up other “in progress” sites after making them wind and water tight, we have seen a gradual return, as in certain parts of the country work is starting once again.

The lending climate has changed however, the GDV lenders are few and far between but will look at smaller residential deals (very few lenders at all are looking at commercial builds unless they are either pre-sold or pre-let to a reputable end user) up to say £3m.  They limit their total advance to about 50% of the GDV and expect the developer to exhaust his own funds first before drawing on theirs.  Interest rates are higher often 9% p.a. and if the interest is to be rolled into the deal rather than separately serviced, the 50% limit has to allow for payment of these  as well.

The banks are still there in a minor way but are not keen to lend in excess of 50% of the land costs, and a similar amount of the build costs and there will always be the need to jump through an extensive array of “hoops” first, so don’t expect them to be major players for quite a time to come.

We are seeing green shoots, and the demand will always be there for housing stock to satisfy the British desire to own their personal bit of real estate, but unless the deal represents a very attractive return, there will be challenges for quite a while to come.

If you have a development project you would like our input on do let us know and we can point you in the right direction.