Home Banking Government Should Help SMEs Raise Equity and Not Debt Capital

Government Should Help SMEs Raise Equity and Not Debt Capital

by internationalbanker
Featured Image - Cavendish Corporate Finance

By Lord Leigh of Hurley, Senior Partner at Cavendish Corporate Finance LLP, Deputy Chairman of finnCap Group plc




Near the beginning of July, the United Kingdom’s state-owned development bank, the British Business Bank (BBB), and the trade association for the UK banking and financial services sector, UK Finance, announced that they had embarked on exploratory discussions with leading commercial banks, such as HSBC, in order to agree on a much-needed debt-collection ”code of conduct”.

Although no deadline has been set by which the talks must be concluded, the code is intended to guide banks pursuing small- and medium-sized enterprises (SMEs) that fail to make repayments on their UK Government-guaranteed coronavirus loans. Many struggling businesses will likely be hoping that, in comparison to other commercial facilities, the guidelines set by these industry-wide discussions will result in banks taking a “lighter touch” approach when collecting outstanding coronavirus debts.

But whatever the exact nature of the outcome, the fact remains that a sizeable proportion of the Bounce Bank Loan Scheme (BBLS) and Coronavirus Business Interruption Loan Scheme (CBILS) borrowers could default on their loans, meaning significant losses for banks, the UK Government and the national economy as a whole.

It is for these very reasons that I strongly believe that in order to mitigate the tangible risks posed and to facilitate business growth going forward, a greater number of measures by which businesses can raise funds without increasing their debt burdens ought to be made available to them. In particular, alongside the existing ways through which to raise equity, such as listing on AIM, government ministers should look at implementing a mechanism by which equity can be invested in debt-saddled SMEs—and this needs to be done quickly.

Burgeoning debt piles are a problem for all involved.

Loans that accredited lenders have made under both BBLS and CBILS are guaranteed by the UK Government but to different degrees. Whereas CBILS loans come with only an 80-percent guarantee—leaving banks to foot 20 percent of the cost of any unpaid facilities—the UK taxpayer will cover any losses that banks incur from BBLS loan defaults. Thus, BBLS loans, whilst posing little risk to banks, pose a significant risk to the national balance sheet.

However, in order to reduce the scale of the possible losses here, banks must adhere to a crucial government stipulation: before being permitted to take advantage of the loan guarantees, banks are expected to attempt to recover the full amounts owed by both CBILS and BBLS borrowers. This is where the crux of the problem lies—and, indeed, it is the reason why UK Finance and the BBB are looking to outline a debt-collection code of conduct for commercial lenders pursuing businesses that have defaulted on their UK Government-backed loans.

Usually, of course, established lenders follow their own individual policies and procedures when pursuing borrowers who have defaulted on loans. But, since BBLS and CBILS are not products specifically offered by a particular bank and are instead government initiatives, it seems only fair that a universal standard for collecting debt be consistently and carefully applied to all accredited lenders taking part in the respective emergency-loan schemes. These schemes are, after all, novel and innovative responses to the unprecedented impacts of an unprecedented crisis.

Nonetheless, whilst I do strongly welcome the current attempts to establish a code of conduct for banks pursuing coronavirus-loan repayments, implementing guidelines to ensure that struggling borrowers are treated fairly will not reduce the number of poorly financed SMEs likely to default on their emergency coronavirus loans in less than a year’s time.

Indeed, the Recapitalisation Group has released estimates that suggest that UK businesses will be saddled with somewhere in the range of £97 billion to £107 billion worth of unsustainable debt by March 2021, and £36 billion of that amount will be due to coronavirus loans. Furthermore, anywhere from 40 to 80 percent of the £30 billion worth of BBLS loans made so far this year could turn toxic in the same period of time, spelling trouble for the government’s coffers and possibly the UK’s hopes of a full economic recovery, too.

Government should turn away from debt and look to equity funding.

To reduce the historic levels of sovereign and corporate debt gripping the national economy but nevertheless facilitate businesses in raising the funds they need to help them survive the challenging economic environment, I believe the UK Government must consider establishing a mechanism by which to invest equity in SMEs that have borrowed under BBLS and CBILS and look likely to default on these loans. It is of fundamental importance that this mechanism is not controlled directly by the government, however; agencies and institutions with the appropriate skill and expertise in making and monitoring relatively small amounts of equity investment on a national basis ought to be in charge once it has been established.

Yet, supposing the government were to follow this advice and create such a policy, the problem is still that such a mechanism needs to be implemented quickly, before some of these struggling BBLS and CBILS borrowers start overtrading—but, critically, it is unlikely that a new purpose-built organisation could be created within the next six months.

The good news is that a possible way to circumvent this challenge has been posited by the centre-right think tank, Onward. In their “Bounce Bank” report released in July, around the time the BBB and UK Finance launched their exploratory discussions, Onward recommended allocating more money to institutions such as the BBB, Business Growth Fund and British Patient Capital for convertible loans that can be turned into equity if borrowers are unable to repay the loans. Not only would this reduce the strong upward pressure on corporate debt, but it would also more closely align the interests of lending banks with those of borrowing businesses. To add to its advantages, taking equity stakes in borrower-SMEs would provide those businesses with interest-free liquidity, leaving their growth potential unimpeded, whilst correspondingly giving banks the opportunity to recoup more of the money they have committed in the medium to long term—it is a win-win all around.

At the same time, of course, it should not be forgotten that there are additional existing options readily available to companies needing to raise equity without taking on more debt; for example, companies in need of funding can always list on AIM. Moreover, not only have AIM-listed companies performed well in recent months, with the index recovering quickly from the impact of COVID-19, but launching on the market provides immediate access to equity.

Investing equity in SMEs is in the national interest.

So, implementing an industry standard for banks to pursue businesses defaulting on coronavirus loans is, of course, a worthy measure following the UK Government’s excellent work in providing the nation’s SMEs with access to emergency finance. Nevertheless, ministers and officials should now be concentrating on reducing the UK’s sovereign and corporate debt burdens—along with addressing the plight of the many SMEs saddled with coronavirus loan debts that they will be unable to repay.

Increasing the ways in which struggling companies can raise equity is the obvious answer. And beyond encouraging SMEs to list on AIM, finding ways for the UK Government to take equity stakes in businesses, albeit indirectly through the likes of the BBB, is a sensible further development on existing coronavirus funding policy. Such a mechanism would provide lenders and the UK Government with a way to regain the capital they have committed. It would also reduce SMEs’ debt burdens, providing them with liquidity and encouraging their growth both in the short and long terms.

And, ultimately, such a mechanism would, therefore, help maximise the UK’s chances of a quicker economic recovery than might otherwise be.

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