1. Introduction

This guide looks at the role of the investor and the businessman. Most businesses have an overdraft and either suffer their bank manager as a necessary part of the business, or assume he is only to be used in a crisis.

In looking at the fund provider to a business, he may be a friend, a partner, an outside investor, a bank or the trade creditors to the business, each of these parties invests money and require the business to fulfil certain obligations with regard to the safety of their money, payment terms and general business performance.

The trade creditor supplies goods and expects to be paid for them within a reasonable period. Before supplying the goods he has to be satisfied that the business is safe and it will have the funds to pay him.

The businessman on the other hand goes to great lengths to convince his suppliers that his business is sound and profitable, he knows that without a regular supply of materials/goods his business cannot continue. Some suppliers require audited accounts, trade references and/or bank references prior to allowing credit to an agreed level.

All providers of money to the business have different aspirations and requirements, this briefing will describe those requirements, and how you should organise the business to provide them.

2. Why do you need a relationship?

As with the example above it can be seen that in order for the business to continue, anyone providing a service to the business must be looked after.

They must be treated as a partner in the business for without them the business would cease. Take for example a bounced cheque, it does not take long for the word to spread across suppliers and give you a poor credit rating. If your relationship is good with your main suppliers it will be considered as a hiccup, if not.........?

Each of the fund providers must be looked upon as a partner no matter how much the businessman feels ill at ease. You must put yourself in their shoes and ask yourself, "what would I want and do?". Anticipate the providers requirements before he asks, by doing this you gradually slip to a second or third priority and avoid direct conflict. If one of your customers fail to pay on time every month, he will be the first debtor to be hassled by your company prior to the due date. The object of the exercise is to get the business on a back-burner with regard to the fund providers.

3. Why do the Fund Providers need a relationship?

Like yourself the fund provider wants to stay in business, make a profit, and expand. You are his customer, without you he has no business. All to often the approach is that "they are just bankers", one does not have to like the investors but they must be provided with their requirements, both tangible and in-tangible, for the business to succeed.

Take an example of the Chairman of a large multi-national, should he deride his investors, the rumour grows and it is then reported in the press, be it Institutional investors or old Mrs Farquar of Cleethorpes, they will be uneasy, and the share price will drop. The result could be that the Chairman will be looking for another job.

As you can see a relationship with investors to a public company is paramount, whole Public Relations departments are set up just to satisfy this need. In a smaller way, every business should have this objective as a priority. Good relationships do not happen by accident, they require planning and implementing.

4. Money as a commodity

In all the discussion so far it can be seen that money is the same as any other raw material/product used by the business to produce goods or services for sale.

This is not an easy concept because one sells goods or services to get money, but money is an essential part of the work in progress cycle.

Raw materials (creditors)
Assembly (stock)
Ready for sale (showroom stock)
Sold (debtors)
Money received(bank account credited).

This cycle either goes too fast or too slow, in both cases it produces a strain on the financial resources. When this happens how are the relationships with the trade creditors, the family investor, the mortgage company, and the bank?

5. Small business growth pattern

0-3 years         
One man band: the man that had the good idea
Under capitalised: businesses are usually started with little capital Inexperienced: Usually only proficient in the area of his past experiences Runs everything: Cannot afford staff so does everything
Establishes business and products: gets business off the ground

2-5 years        
Employees: cannot cope so is forced to take on people
Delegation: forced to hand down some responsibility
Rising overheads: The increase in sales causes overheads to rise to manage those sales, which in turn increases overheads again
Overtrading: The need to trade outstrips the profits accumulated to handle the increase
Management by crisis: Due to the swings in trading

5+ years        
Finance expansion: Crisis management becomes unbearable and the business is forced to re-finance                         
Maintain business position with new products: the original products are now on the down cycle and replacements need to be developed
Control by delegation: forced complete delegation
Indecision of future business structure: Now business is on a controlled path should it be Ltd, plc, partnership, or flotation.

As can be seen in the early part of the business growth the owner is handling areas where he is probably least adept, namely finance. New business skills require learning, new man management skills require learning. If the owner does not let go of his total control and manage by delegation the business will plateau and then decline. At each time period the fund providers will change as will their requirements and the relationship with them must be managed and planned.

6. History

Controlled by legislation.

In the 1920's case law laid down the duties of banker's, which included rules relating to cheques, how interest could be charged and the responsibilities of the customer against fraud or forgery. Customers were seen as a part of the family, all decisions could be taken at High Street level and you were a customer for life. All banks are controlled by legislation with regard to code of conduct and asset cover.

7. Changing phases of the Bank position

In the 60's and 70's banks moved into marketing with identification of all their product areas. This was seen as an attempt to respond to competition from other forms of finance that had become available. The gap between bank and customer widened as customers obtained their funds elsewhere. Relationships became strained during this period.

In the 80's when property prices escalated, the banks adopted a "belt and braces" approach to lending, causing much dissent with businessmen. Any finance could be covered with property as security with little account taken of the business owner, and of the potential of the business. The businessman treated the bank as low class supplier, for if the bank did not respond positively funds were available elsewhere.

In the late eighties the economy moved into recession, credit became tight and business had to turn back to the banks for supply of funds. The pendulum had swung both in the business world and with the banks.

Today banks want longer term relationships in order that they may assist the business and protect their investment. The danger is that the bank sees you as the same man that started the business some years earlier, when in real terms the business is on another plain. If the business had managed the relationship more effectively, this would not be the scenario.

8. The Umbrella syndrome

The old anecdote used to be " the banker gives you an umbrella when you join him but as soon as it starts raining he takes it away". Given a good relationship this is a thing of the past. 

Summary

In summary of the first two parts of this guide it can be seen that both fund providers and their customers require a positive relationship. The bank must be given the same priority as any other main supplier of goods/services. The needs and requirements of each party must be planned and satisfied.

9. Relationships with fund providers

The fund provider can come in a number of forms and each will require a specific relationship plan.

Sleeping/active partner
This partner will want to know very regularly how the business is getting on. He will also be concerned as to the security of his funds. He may want repayment so that he can concentrate his efforts elsewhere. Partnership disputes are frequent and usually resort to a buy-out.

Family finance
This is as above with the added concern of the family home, retirement considerations when the member of the family may wish to realise the investment. This relationship is the most difficult to manage because non business items will also cause problems.

Outside investor
As with the partner requirements he may want a regular return to supplement his income, any downturn in the business and he is directly affected. The relationship will require regular formal reports and clarification meetings.

Shareholder
The shareholder is a long term investor but still requires a regular return and notification of business progress and changes. Normally annual accounts and report are adequate, with special report for significant changes.

Banker
The bank is responsible to its shareholders and is held directly accountable for losses. The banker will want proof of profitability of the business so that he may feel his investment is secure. If the business is in profit, the bank will profit. Regular reports and clarification meetings, very early notification of significant changes.

10. The Investors/Banks objectives

The bank wants to be associated with profitable businesses so that it can increase its profits and pay a good dividend to its shareholders.

Where a business with a good record has declined the bank would like to be involved to understand the problems and provide assistance where necessary.

The bank does not like surprises and has difficulty responding quickly to crisis. If the business only has a relationship with his local manager, the manager will have to convince his colleagues at Regional office or business centre to proceed. For large sums it may go further to area office.

There is a danger that through the intended goodwill of the local bank manager he will hold on too long before informing regional office, in the hope that the business will recover. This sometimes happens when the businessman successfully sells a "jam tomorrow" story to his manager. When the crash comes the local manager has nowhere to go and liquidation is inevitable.

11. The Business objective

The bank expects accurate and timely management information. This can be achieved quite successfully with the annual audited accounts, this of course is of little use in the day to day running of the business.

Monthly management account must be produced within 10 working days to be of use to the business, the degrees of accuracy are wide. A confidence factor would be if the management accounts record a similar profit to the audited accounts. Should this not be the case due to exceptional items or differences in the method of accounting, a reconciliation report should be produced highlighting the differences.

The best laid plans do go adrift, and when they do, inform the investor before it becomes evident in the account. Refinancing may be necessary and if the relationship is right it will be available..

Each of the three main clearing banks have 350 or so regional offices or business centres. It is vital that you know and cultivate your contact at that centre.

12. The difficult ladder to complete trust

The objective of the businessman must be complete trust with his fund providers and they with him. This is very difficult to achieve and must be measured regularly as to your position.

The Mutual Trust Ladder

Level 1: Communication by default
            The business only responds after a direct request by the lender.

Level 2: Understanding
            The lender begins to understand the business/businessman.

Level 3: Responsiveness
            Both business and lender respond quickly to each others requests

Level 4: Positive help
            The bank offers unsolicited help with problems.

Level 5: Mutual confidence
            Both parties respect each others position.

Level 6: Mutual trust
            Each party can depend on the other to play by the rules, and will             receive assistance when problems occur.

Levels one and two must cause concern to the businessman and difficulties will arise. Level three is an encouraging sign that improvements can be made. Level four is a minimum that must be aimed for. Level five is difficult to achieve. Level six is near to impossible. A strategy must be developed to measure your position on the ladder and actions necessary to move up.

13. The Language Barrier

Each of the fund providers has his own business language, as does each type of business. Initially he doesn't understand yours and you his. If the relationship is planned you teach your investor your language and learn his.

The objective on both sides must be not to appear as an expert, if this happened both sides would feel threatened and retreat into the safety of their own business/bank.

Buzz words are useful providing they are understood.

If the initial ground rules are that he does not understand your business, which must be the case, it is quite reasonable that you do not understand the bank/investors business. This is a good basis to prepare a learning strategy for the investor, which will increase the trust, and move you up the trust ladder.

14. Financial "Horses for Courses" or the right finance for the right application

The financial structure ranges from interest free non repayable family loans to Venture capital to leases. The type of finance must fit the job it is to do, one would not take a ten year lease out on a vehicle which is to be used by a representative. The representative would be four cars on in the ten years when you were just completing payments on the first car.

15. Types of Finance

Working capital - Overdraft Repayable on demand
Invoice discounting - Debtor related
Factoring - Debtor related
Suppliers - Creditors
Vehicles - HP/leasing Repayable over the life of the vehicle
Machinery - HP/Leasing Repayable over the life of the machine
Term loan - Repayable over a fixed period
Land & Buildings - Term Loans Long term
Commercial Mortgage - Long term
Equity - Savings
Company Purchase - Term Loans
Government - Guarantee Loan
Shareholders - Equity Investment
Venture Capital - Repayable at a fixed exit time

All the above require a relationship strategy, HP/Lease to a lesser extent. Each type of finance could be on a different rung of the Trust Ladder. Each will require a strategy to hold and/or improve the current position. Remembering each will have its own language barrier.

15. Who do you "get into bed with"

The finance provider will depend on the usage of the funds required. Looking at the table above gives an indication of the type of finance related to usage.

As a general rule the bank provides the facility for day to day trading. The amount depends upon the security available as will be discussed in a later section. To enhance your relationship provide the bank with a monthly report with figures. For smaller businesses these could be on a cash basis to a reconciled bank statement, as the relationship progresses these figures can be enhanced and developed. For the medium company full monthly accounts with a narrative. If this course of action is followed, remember as mentioned earlier, the annual audit accounts must equate with the cumulative monthly accounts. If they do not equate, you will drop a rung on the trust ladder.

For term loans the above practice should be in place prior to the application. The bank/institution will require forecasts and monthly accounts so that they may be comfortable that the repayment and interest schedule can be met.

Venture Capital providers will require extensive information with regard to the operations of the business. This will include market research, marketing plan, personnel plan, growth plan, and the normal reporting requirements.

16. Understanding the finance decision

Asset Backing
The fund provider will require a level of security for the funds borrowed.

The following asset valuations will apply:
Goodwill - zero
Debtors - 50% of good debtors
Stock - 10 to 25%
Machinery - 5 to 40%
Buildings - 50 to 70% of valuation

Level of debt/equity
The lender will be concerned as to the level of equity in the business, this will be from funds provided by the owner or shareholders plus accumulated profits.If the ratio falls near to 1:1 or less the lender will have serious concerns, 1.25 equity to 1 of debt is a minimum level to target.

Level of interest/dividend cover
All investors be it the family or an institution will wish to know if their regular income is well covered. The ratio is the number of times out of the profit, the interest/dividend could be paid.

Capacity to redeem capital and debt
The lender will require constant confirmation that the borrower has the ability to repay the loans. This information should be constantly sent to the lender in order to move up his trust ladder. The more confident he is that payments will be made the less demands he will put on the business.

Growth potential
The investor will require evidence of growth to ensure that the debt becomes a smaller and smaller proportion of the total capital base. A Venture Capital institution will only invest in a growth situation.

Projected working capital
The lender will wish to be sure that the new money introduced will satisfy the business requirements for at least a year. If the planned expansion requires additional traunches of money they should be pre-planned. Un-planned refinancing of the business causes problems to the lenders that are already tied in to the business, as they are in a dilemma. Should they throw good money after bad? or, is the business relationship far enough up the trust ladder that they will provide the re-finance. This will certainly cause a drop in the trust ladder, subsequently, which will have to be recovered.

Potential risks in the business market place
The lender will investigate the market place of the business to measure the risk. If it is a new product into a competitive area he will be hesitant.

How the equity holders are tied in to the business
The lender will require assurance that the business owner has a moral/financial reason to keep the business going and advancing. In the early stages of a businesses life the owner is the business, without the commitment of the owner the business could fail. If the collateral in the business is inadequate, and the owners home valuation is inadequate, the lender may still tie in the family home to ensure the owners commitment to the business.

17. Type of finance vs. security

Debt finance
Government guarantee loan no security needed
Term loans                             security
Commercial mortgage               assets security/land building
Overdraft                               net assets
Factoring                               debtors
Invoice discounting                  debtors
HP/Leasing                             equipment/vehicles
Creditors                                no security

Equity
Personal funding                       savings and/or personal loans
Outside private investor             no security
Venture Capital                        no security
Business flotation                     no security

Conditions
How much finance                 the amount required must be precise
What the finance is used for   usages must be specific and measurable
How it is to be repaid             periods
Downturn situation                ability to go back to funding providers for                                          re-finance
Security Offer                      precise levels of security, leaving room for                                          negotiation

Exit routes
An investor/bank will have a specific way in which he will wish to realise his investment, this must be accepted and catered for in the business planning.

Payment on demand
Term                                    paid at the agreed intervals
Sale of assets                        to release funds
Re-finance                            to release funds
Company sale/amalgamation     sale of shares
Flotation                               sale of shares
MBO                                     management buy-out
MBI                                      outside management buy in
BIMBO                                  a mixture of the two above

The trust ladder with each type of finance must be related to a strategy for increasing the effectiveness of the relationships. The following section examines methods that can be used.

18. Information requirements

Related to type of investor
The amount of information must be only one step beyond that which is required.

Types of information
Annually
Annual accounts
Annual report
Business plan

Monthly
Management accounts
Market research
Owners/directors report

Random
Business literature
Press cuttings
Adverts for personnel
Market reports
Performance to business plan 


19. Conclusions

A. Strategy
The process of a good relationship must be planned. Objectives must be set and measured on a regular basis. After any event resulting in change the new position must be analysed to cater for the new situation.

B. Information
Information is the key to a good relationship. This information transfer includes the written and the spoken.
Information must be matched to just ahead of the lenders requirement, saturation will cause a negative effect.
Present the right information at the right time.

C. Trust ladder
Use the trust ladder to evaluate and measure the levels achieved with each fund provider
Target levels to achieve by a particular month end, match the actions necessary to meet this time and target.

D. Fit finance to requirement
Try not to mix "apples & pears", fit finance to the requirement. If the fit is incorrect have a strategy to bring them into line.

MORE INFORMATION
If having read this guide you would like to discuss how we may be able to help you, please call us on (01373) 454576 and speak to Peter Beech-Allen, or E-mail a request to us for further information.