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…

 

 

Bank Appeal

Bank turned you down?… Is Appealing Appealing?

If your company’s been turned down for funding by your bank is it worth appealing?

Yes !

Roughly a third of appeals succeed… and for some banks it’s higher…

There are a few reasons why appeals work… (e.g. you might supply more or better info on your company during the process)… but I suspect a fair bit of it is having someone else within the bank take a look at your application… someone at a higher pay grade and with greater authority & capacity to take a risk…

Who cares why… appealing works for a third of applicants

Simply follow your bank’s appeals process… or do it totally foc through Better Business Finance 

… but act quickly… there’s a 30 day limit from the day you’re turned down…

… and then within 30 days of your appeal you’ll know if you’re one of the one in three who get what they want…

… and if you’re not… the banks are now supposed to recommend you on to another funder who may well give you the money you need (something I’ll blog about soon)

So why do they turn down companies in the first place?

Bank Appealing reasons for refusal

The single biggest reason for refusal is a poor Credit Score…

… but frankly there’s no reason to let your Credit Score get in the way… if you ‘manage’ it in the month or so before you apply for funding you can get it up where you need it to be…

… it can be easily done (sign up in the sidebar for a free book on understanding UK Company Credit Ratings and boosting them)

… and nobody dies…

My 2p worth… Here’s Hoping the Successful Appeal Rate Falls ???

Professor Russell Griggs OBE  independently monitors and reports on the banking sectors’ appeals process…  and like him I’m hoping the % of successful appeals keeps falling as it has done for several years…

… because I’d take it as a sign that the banks’ appetite for lending to SMEs is improving… so fewer companies that should get funded don’t…

… and those SMEs that get refused & then appeal will increasingly only be those that don’t play the game when it comes to tidying up their Credit Score and fail to prove the affordability of the funding they’re seeking…

.. basic stuff to get right before you apply imo

Sources :

Better Business Finance 

 

The problem with banks… ?

It’s bankers’ outdated obsession with security that’s stopping SMEs borrowing…

A typical owner managed business looking to their business banker for funding will end up being asked for Personal Guarantees to secure any loan… and that’s got to stop

The desperate will always sign whatever the bankers want… but the rest are increasingly turning away from bank finance… and who can blame them…

Last month I was with a solid, established company who have a real growth opportunity. The middle aged owners have run the company profitably & completely debt free for over a decade, and for all that time they’ve been with the same bank… yet they didn’t get the modest business loan they wanted… why?

Because after supplying all the historic accounting information (which their bank had already been given), filling in all the forms, doing a we-all-know-its-useless-but-ya-gotta-do-it forecast, and emailing, phoning, meeting their lovely manager… the bank insisted on full Personal Guarantees for the whole loan…

These people have homes, with mortgages paid off, teenage kids etc … why the hell would they take the business risk so deeply into their personal lives that they could end up homeless at their age & after all their efforts?

Strikes me all the risk was on their side…what real risk were the bank taking when offering a loan that’s more than fully secured?

My gripe is… interest rates charged on loans are supposed to reflect risk… the higher the risk, the higher the rate… so let the rate take more of the strain… and drop the obsession with security

…or let’s be really radical and offer a company 2 rates… a lower one with Personal Guarantees… a higher one without any…

Security : how it works
This obsession with security & personalising a business’ risk is a real problem for the economy as whole (and for a Government that wants you to borrow)

It means banks effectively ignore any drivers of growth within the business (customer base, order book, employee skills, market position), and concentrate far too much on tangible assets to support any lending.

They make that even worse by applying ‘risk weighted asset’ models … which normally means ignoring most of your assets, like Stock or W-i-P.

It also means ignoring Debtors (which is why they try to push you to invoice discounting or factoring… they can’t lend against your Debtors… but they ‘know-a-man-who-can’)

So you’re typically left with tangible Fixed assets… which usually means Property.

For most Owner Managed Businesses this all means they haven’t got enough assets in the business to support the bankers’ obsession for security… so it gets Personal with Guarantees required.

Your manager : how he works
Your bank manager has almost no impact on the situation… they just package up the deal proposal to pass on to a remote credit committee…

That ‘committee’ makes a decision & sets terms based on a few of things, but they will :

1.check your company credit ratings : if you’ve met me you’ll know how important I think ratings are nowadays… banks take these ratings and employ a few twists of their own…

eg typically ‘Head Office’ will rank your sector (often in a traffic light scheme)… and the rankings are always changing…

… so a builder might find it easy to borrow today because construction is ‘green’, but next month it might be ‘red’ as the bank tries to reduce exposure to the sector or have a more balanced loan book… and now the builder won’t get the loan

2.check your bank manager’s record : after years of successfully not losing the bank’s money and only putting to the credit committee deals that they’ll accept, a manager will be given an internal score or % that improves as time passes…

I know an 80%er… and a 95%er…  the 95% banker is as close to ‘can-do-the-deal-guaranteed’  as you’ll get… but just you try getting him to take on a deal that he’s happy to put his name & score to and that he’ll push up to the Credit Committee…

(as an aside this is why sometimes the process can take so long… your manager may be stalling because he knows your current credit rating & sector rating means you’ll get knocked back.. and he doesn’t want to see that happen (it hurts you & his own internal score)… so he may spin things out to see if you or your sector rating improve… and of course they hate to say an outright ‘no’ because then you’ll go elsewhere !)

So what’s to be done?

I work with some cracking bankers… and they do genuinely want to lend and support the SME sector… and the fact that you guys aren’t borrowing is genuinely puzzling them…

So.. assuming that encouraging SMEs to take on more debt is a good thing… how about we :

1. get rid of bankers’ anachronistic reliance on Personal Guarantees
2. reduce their obsession with security & their reliance on ‘risk weighted asset’ models (which struggle to work for younger, service based businesses)
4. let the interest rate alone reflect more of the risk of the loan

And if the interest rate then gets too high… and the Government still wants to interfere with the market to get SMEs borrowing & growing again… they can subsidise the rate & get it down to a better level…

But it’s not interest rates that are the problem… or access to finance in the first place (only 9% claim it’s a barrier according to the SME Monitor, down from 15% 2 years ago)…

It’s the banks, and the terms they demand.

Are you a Permanent Non-Borrower?… you’re not alone…

A third wouldn’t borrow money – even if they were paid to ?

 Owner Managed Businesses (SMEs) are becoming increasingly self sufficient and shunning all forms of borrowing…

31% are now classified as Permanent Non-Borrowers (PNBs)… the highest level to date and up from 20% in Q1 of 2012…
That’s a problem for the Bankers et al who finance SMEs because roughly a third of SMEs have had no ‘borrowing event’ in the last 5 years, and don’t plan to have one in the future either…

And it’s a problem for Westminster too… keen to squeeze finance into SMEs to ramp up growth into the next election cycle.

But it’s also a problem for guys like me… bred on the Anglo raw meat ‘debt is good’ diet…
So what’s going on? Why won’t an increasing number of you borrow?
Well it’s not really the economy that’s putting SMEs off…
Those citing the Economy as a barrier to their business are down to 16% from 33% in Q1 2012
And it’s not the availability of debt…
Those citing Access to Finance as a barrier are down to 9% from 15%

And it’s not that they don’t expect to grow…

In fact 68% of SMEs with 10 to 49 employees do (up from 56% in Q1 2012)…

and 57% of those employing 1 to 9 people (v 51%)

So… is it :
profits are up and being retained thus reducing the need for external funding?
the bunker mentality of the recession years is proving hard to shake off?
the numerous finance scandals (global & local) have shaken already shakey trust?
the pace of expected growth is too slow to warrant any major funding change?
traditional funding processes are too demanding, too slow, too painful?
as businesses recover is there less need for non-growth / emergency related funding?
are you avoiding anachronistic Personal Guarantees?
or are you all too busy playing the property / buy-to-let boom & would rather borrow privately for that than borrow to invest in your trading companies?
I don’t know…
I do know that there is a lack of awareness out there about all the weird & wonderful new forms of finance popping up…
Take an alternative funding source that is now going mainstream… peer to peer crowd funding (Funding Circle, Rebuilding Society)… only 17% had heard of it… yet given the flexibility, speed & all round user-friendliness of these funders I can’ t help but think that if that number were higher… the number of Permanent Non-Borrowers may well be lower.
Data sourced from SME Monitor