DSCR what it is and why it matters

DSCR is the Debt Service Cover Ratio required by bankers… typically when they are ‘cash’ lending for an MBO, acquisition etc

They want to make sure a company’s annual Cash Flow can cover its annual Debt repayments… and they add a little bit on for comfort

So… let’s play numbers

If a company has £100k Debt repayments (including interest)

And their Bankers apply a DSCR of 1.3

Then the company must have CFADS (Cash Flow Available for Debt Service) of £130k to keep their Bankers happy

In the Real World

The calculation is done the other way round… so

Say our company has CFADS of £500k

And their Banker’s DSCR of 1.25

Then the company has a Debt repayment capacity of £400k

The Bank will then deduct any existing Debt repayments (Funding Circle loan, HP payments) … say e.g. of £100k

The Bank now thinks the company can cope with an extra £300k of Debt repayment each year…

For an MBO they may typically lend over 3 to 4 years… meaning our company can borrow an extra £900k to £1.2m

CFADS

Obviously DSCR is just about symbiotically linked to CFADS… so check out the post and video on CFADS here

 

CFADS how to calculate it and why it matters… and it does

CFADS is a measure of a company’s Cash Flow Available for Debt Servicing… and it matters because Bankers like it… so if you’re looking at an MBO or going on an acquisition spree chances are your bankers will look at your CFADS to see if they want to come along…

Calculating your CFADS… and how much they’ll lend you

Here’s a video working through the nuts and bolts of calculating your CFADS & what a bank’ll lend… and if you want a spreadsheet to help you out drop me a line at pete@pete-wild.co.uk

Essentially Banks :

1.Caluclate your CFADS

2.Adjust for their required DSCR (Debts Service Cover Ratio)

3.Deduct any existing Debt repayments you’re making

4.Multiply the result by 3 or 4

And that tells them what they can afford to lend based on the company’s ability to generate enough cash to pay them back

In the Real World

What if your CFADS won’t get you the cash you need?

All may not be lost if your CFADS doesn’t quite support the money you’re looking to borrow…

… in the real world the banks are often trying to work to a figure you need them to hit because that’s the number you’ve agreed for the MBO or acquisition…

… so your Banker may well work with you to help get the CFADS figure to where it needs to be (see the video above) … hey… your Banker has a target to hit, bonus to earn, and he knows that if he says no you’ll be off somewhere else…

… and bankers hate losing clients

MBO … you know it makes sense

I’m seeing an increasing appetite among bankers to fund an MBO… which is a great thing all round.

Owners get to sell all or part of their holdings and realise value… to people who know the company well and are seriously committed to making sure it survives and thrives

Bankers get to fund a team who know the company warts & all, yet still want to financially hitch themselves to the company wagon for years to come… And if the Bankers funding the deal are the company’s long-time bankers, with a real knowledge of the company and its prospects, so much the better

And there’s more… much more

Not only do seller and funder get what they want (value extracted … chunky low-risk funding)… they get it quick… and I mean quick

High Street bankers can and really do turn an MBO around in less than 2 months.

Think about that.

8 weeks from today you could have sold out… if you’ve a team who’ll buy

Compare that to the market…

I typically tell owners to expect to wait a year for their money if trying to sell in the market… and not to expect any deal to go through… because few do…

A willingness to get the deal done, quickly, by all involved, with minimal-to-no Due Diligence helps cut the time… as does the comfort the bankers get from funding a team who know the business better than any Due Dil team could

CFADS

For the Bankers an MBO is a form of cash lending… they look less for security and more for an ability to repay… and to measure that ability a lot of them lean heavily on the company’s CFADS

I’ve a separate post on CFADS for the seriously interested… but for the passingly-curious it stands for Cash Flow Available for Debt Servicing

Once the Bank have calculated a company’s CFADS they knock off any existing debt repayments the company has… add a margin of cover … and will typically lend up to 3 or 4 times the remaining figure

In the The Real World

Your Company Valuation is irrelevant…

Again… think about that… the Bank works out its willingness and ability to lend you an AMOUNT… no mention of value here…

… so that amount could be for all your shares… or just 70% of them… leaving you with 30% as your team take on the business…

… in fact your Bank would prefer it if you don’t sell out entirely… no whiff of ‘cutting & running’… plus the old owner is still around to help the new owners…

So what’s the catch?

You still need all the deal-making & legals doing right

Heads-of-Terms… an SPA (Share Purchase Agreement)… a Shareholders Agreement… as well as any Service Agreements (e.g. for your new role, and for their new roles)

And the bank will want all the forecasts they can eat…

But none of that stuff should stop the deal happening within 8 weeks from now

Wow

But what about the M in the MBO ?

For Management this will be a big step up… and in the old days it meant lots of  PGs (Personal Guarantees) and some skin in the game (in the form of perhaps one year’s salary)

But the old days are gone… we are in a world awash with cash… and the banks aren’t pushing for skin… and any PGs can be limited to silly low numbers (which the selling owner can guarantee if that helps get the deal done)

Interesting times… 

I’m absolutely convinced there are no meaningful supply side issues when it comes to companies like yours getting funding… it’s the demand that’s lacking…

… and I’m also absolutely convinced the banks keenness for these MBO deals is strongly correlated with this supply / demand mismatch…

… long may it continue…

 

 

Innovate

R&D tax reliefs and grants work … will Patent Box work better?

Innovation is one of the best drivers of growth for an owner managed business… and luckily the Government really does get it… offering some bonkersly brilliant and accessible help that actually works for companies like yours…

As a form of Corporate Welfare (which I’m generally against) these innovation-orientated tax breaks and grants rather surprisingly do what they’re supposed to do… boost productivity and create jobs (which I absolutely love)

Innovate UK are busy getting grant money out to innovative firms… and, as the Enterprise Research Centre recently reported, the range of grants available has made a real impact… Over a 13-year period, R&D grants spurred growth worth £43bn to the British economy – more than five times the £8bn invested – and created around 150,000 jobs

… one helluva an ROI

But R&D Tax Reliefs  are doing even better imo… not only does research suggest this tax saving for SMEs is working financially…  Our current evaluation suggests that for each £1 of tax foregone, between £1.53 and £2.35 of R&D expenditure is stimulated… I believe it is changing the mindset of some of the companies applying…  

What started out as an attempt to justify a claim for a extra tax deductions and get money back from HMRC… is morphing into a mindset shift for the companies involved as they start to genuinely put innovation at the heart of what they do…

And I think the Patent Box could take that shift towards innovation to a completely different level…

The tax relief for having a Patent is now so good that companies I tell about it immediately start to think what they are doing or can do that’ll lead to a narrow patent and get them a 10% Corporation Tax rate for a couple of decades…

Changing minds is surely one of the hardest things for a Government to do… but, because of these innovative tax reliefs, minds really are changing when it comes to innovation

Here’s a couple of older blog posts on the subject…

R&D Relief

First Claim

Patent Box

And a great (if slightly technical) site for keeping up to date with any odd updates to the tax reliefs…

Keeping tabs on changes to reliefs

 

 

 

finance

Finance further up the food chain…

I like to think this blog is for scale-up owner managed businesses… so here’s a few aspects of finance further up the food chain that may be useful to know as your capital requirements change as you grow…

And since I like to give a few ‘insights & angles’ I’d rather not list all the types of finance available… just pull out a few interesting points…

Bullet Loans

Fancy a capital injection where you make no interest payments and no repayments of capital until the end of the loan… say 3 or 5 years later ?

That means you get to use all of the cash to grow your business… and pay absolutely nothing back for 3 to 5 years…

… and even then you can ‘roll it’ into a new loan…

They’re called Bullet Loans… and larger companies can get them from high street banks… so why not you?

I know a big name bank doing Bullet Loans for guys like you… if you’re looking to borrow £500k or more… and it’s one of those things where the more you’re trying to borrow the easier it can be to get

Private Equity

PE investment companies come in all shapes and sizes… with different specialisms and interests… and for me they differ from Venture Capitalists by liking less speculative opportunities…

PE outfits will gravitate towards companies & teams already well on their way who’d like to unload some (or all) of their shares to professional investors who’ll help drive continued growth…

Once you’ve got EBITDA (Operating Profit adjusted for Depreciation) around the £500k mark, picking up interest from PE outfits gets easier… and if you can show a route map to trebling EBITDA in the next 3 years it’ll definitely get them excited…

Venture Debt

I love finance… it’s an incredibly innovative space… full of developing financing options you may not know of… like Venture Debt

While PE houses gravitate to EBITDA producing investment opportunities… Venture Debt providers will be there for zero profit companies… early stage growth companies… and even start-ups…

I include it in this blogpost because you can’t get Venture Debt for just a few grand… it’s serious money for serious growth prospects…

The debt terms can be very flexible… ranging from traditional repayment models to interest only with balloon payments… but it comes with some rights to convert debt into equity so the lenders can become shareholders in the company under certain conditions…

The lender gets traditional security levels (charges over company assets etc) but the extra risk of lending to riskier companies is compensated for by equity warrants (chance to own shares in a growing company)

Personal Guarantees

As you take in more capital the Personal Guarantees you might be asked to make can get a bit big on you…

… you may not mind PGing a £20k overdraft facility… but PGing a £600k loan might make you & those back at home wince…

You can now insure against a PG being called in… and as the PGs get bigger this option may well suit

But if insurance doesn’t appeal… and if the PGs are called in… there are specialist Lawyers who negotiate with the banks for you and drive the amount you have to pay up waaaaay down… often with a no gain/no pain fee structure…

Loans against your shareholding

Rare as rocking-horse poop… but as your company grows and attracts outside investment you may find yourself locked in…

… you can’t sell your shares… can’t earn money outside the business… and your wages etc may be capped…

And to add to the frustration… your shareholding in your company may be your biggest financial asset… but you can’t use it !

Or can you?… there are people out there who’ll let you raise money using your shares as security.

Interesting times for Finance

Even if none of the above works for you…  the point is… different sizes of companies, at different points in their growth cycles have lots of different options…

… and the financial innovation at the moment can seem absolutely dizzying with oodles of new offerings…

… so…

… at the risk of invoking the ‘Chamberlain Curse’… why not make the most of living in interesting times… ?

 

 

Brett Reasons to Be Cheerful

Brexit : Reasons to be cheerful ?

So we’ve gone and done it… (for now?)… I’m going to leave the hand-wringing, virtue signalling, and Brexit fear stuff to other people… and just see if there aren’t a few reasons to be cheerful for Owner Managed Businesses…

Let me pick some less obvious ones (I do try to work on ‘insights & angles’ in this blog after all)

1. Pricing Power…

The £ dives and the cost of imports skies… leading to inflation… not necessarily a bad thing after close to a decade of ‘disinflationary’ / deflationary pressures…

… and if the general expectation is that prices are going to go up… then you guys may find yourselves with pricing power you haven’t had in a while…

2. Access to Funding…

After the financial crash the Government & Bank of England did a great job of pumping liquidity into the system… problem is it took about 5 years to seep out to businesses like yours… over the last couple of years access to finance for SMEs has really improved, in part due to the new Fintech industry with fast & flexible funders like Funding Circle really helping out

… if the economy wobbles get ready for a wave of money as the Bankers (here & in Europe) try to keep the real economy on track & properly funded… this time it won’t take years for that cash to be accessible by the likes of thee & me… so be ready to have access to more money at better rates

3. Mergers & Acquisitions…

I know Corp Finance guys who are licking their lips right now… as barriers go up they see an increase in cross border M&A deals… and even before any barriers appear they think European companies will be busy ensuring access to our markets by buying UK Owner Managed Businesses like yours… so be ready for the phone to ring

So that’s 3 slightly odd positive takes on the Brexit issues facing SMEs…

There are other obvious ones like amazing Export Opps… with the £ being spanked our exports are way more competitive this week than they were last week… BUT I’m not out to produce an exhaustive list…

What I’d like to do is encourage businesses to leave the passion & drama back home infront of the tele… and flip your mind away from the risks (which are many and scary… and which will be pre-occupying your competitors too)… and ask yourselves are there any opportunities for you from Brexit?

Go on… I dare you…

(and here’s a link to an interview I gave on the Saturday after the vote… bear in mind I was there at Manchester Town Hall through the Thursday night of the count… spent all Friday in meetings pretending I’d had some sleep… and drank slightly to excess on the Friday night… so being interviewed on the Saturday a.m. was not a lot of fun)

Brexit Bits for SMEs interview

 

Entrepreneurs Relief

Entrepreneurs Relief… great news for new shareholders

Entrepreneurs Relief is no longer restricted to just directors or employees of Owner Managed Companies… external shareholders can now take advantage of the 10% rate of Capital Gains Tax on the sale of your company’s shares.

It came as a real surprise when the Chancellor announced it in his latest budget… and it’ll help investors who can’t take advantage of EIS & SEIS

It’s an attractive addition to a package of measures trying to encourage medium term, stable investment in unlisted companies… and it won’t cost the Chancellor a penny until 2019 at the earliest, because it only applies to shares bought after 17th March & held for 3 years…

But as the adverts say… every little helps..

Entrepreneurs Relief… the new rule

Here’s what the Chancellor actually put in his 2016 Budget

Entrepreneurs’ Relief will be extended to long term investors in unlisted companies. This will provide a 10% rate of CGT for gains on newly issued shares in unlisted companies purchased on or after 17 March 2016, provided they are held for a minimum of three years from 6 April 2016, and subject to a separate lifetime limit of £10 million of gains.

grants

Grants… saw this, thought of you…

If you haven’t seen it, here’s a great site for sniffing out grants (& other funding for UK businesses & social enterprises)…

… an email address is all you need…

Idox… grants for business

 

Funding Platforms… a bridge too far?

The Government is forcing banks to point SMEs in the direction of 3 funding platforms when they turn them down for lending… and I’m not sure why…

Why pick only 3… why these 3… in fact why pick any at all?

Government supply-side intervention to open up & ‘perfect’ markets can be worth trying… and their intentions are laudable

But by dictating which platforms the banks must refer their clients to, the Government is picking winners… or rather it is making them… by excluding others from their ‘designated’ list…

Congratulations to BizFiTech , Funding Options , Funding Xchange

… because this intervention brings them firmly into the banking sector’s eco-system & should pretty well guarantee more success than they were having on their own (I certainly know of no companies who’ve used them… and hadn’t even heard of two of these platforms)

But why bother designating funding platforms at all?

Some of the banks had already heeded Vince Cable’s call to help out SMEs that the banks themselves couldn’t help… e.g. Santander were already pointing declined customers Funding Circle’s way…

And frankly the Alternative Finance sector is in rude health right now… and getting feckin’ ruder every month…

The FSB Q1 members survey showed it… nearly 10% applied for Alternative Finance

Screen Shot 2016-04-13 at 10.32.40

The Altfi site shows it too…  the incredible exponential growth the Alternative Finance scene is experiencing is amazing…  and this isn’t chump-change … this is £bns…

Altfi growth

Who wouldn’t like to see a ‘sales’ curve like that…?

And whilst surveys show less than the 50% of SMEs are aware of these funding alternatives (o yeah??).. who reading this blog doesn’t already know they exist… ?

… so whilst I welcome some government intervention in the Owner Managed Business sector… I worry that they’re over-reaching a tad… by trying to pick winners & fix something that looks to me like it’s working pretty well…

… and they may well wake the law of unintended consequences…

eg… as the Alternative Finance scene gets sucked / regulated into the eco-system of the mainstream banks I suspect we’ll see less innovation… which will be a big shame… and certainly wasn’t intended…

… and I also suspect it’ll mature the SME Alternative Finance sector pretty damned quick…

… all it’ll take is a downturn to finish the job off…

… and finish off a fair few of these brave new upstarts too… particularly those that the government and the banks haven’t ‘picked’ ?    🙁

 

 

 

R&D Tax Relief

R&D Tax Relief… use it to raise money?

R&D Tax Relief isn’t just a great way to get HMRC to help fund your Research and Development… you can use it to raise money

Already Claiming?

26% of declines by banks are because of affordability… which means your business plan & forecasts haven’t convinced them that you can afford the borrowing you’ve applied for …

So make sure your plan takes into account that you’ll be paying out less in tax every year you’re doing R&D… or even getting money in from HMRC… (because if you make a loss you can surrender your tax relief for cash from HMRC)

I’ve recently seen business plans from two companies that already claim R&D Relief… and will keep on claiming it year in year out… but their forecasts didn’t take that positive ‘cash-flow’ and profit effect into account…

Not Claimed R&D Tax Relief yet?

Why not? HMRC really are keen for you Owner Managed Businesses to do it.

So much so they’ve recently introduced ‘Advanced Assurance’ ...

If you’ve never claimed R&D Tax Relief before… have Turnover less than £2m… and less than 50 employees… you can go online and see if your R&D plans qualify for this cracking tax break…

… and they will give you a written confirmation that your plans will qualify for up to the next 3 years…

… so when you model your cash flow & profit forecasts you can take account of the reduced tax you’ll pay… or the tax that HMRC could actually end up paying you…

… that will make your plan more realistic… and any funding you’re trying to raise will look more affordable…

DIY

Like me, HMRC are aware that a lot of you have accountants / advisors who aren’t working the R&D wrinkle for you… so they’re happy for you to go DIY… take a look… the Advance Assurance is all done online…