May 31, 2012 12:01 am

Smaller companies: A capital idea

worker checks pipelines©Reuters

Stats Group, an Aberdeen-based engineering business, faced problems getting working capital

For most entrepreneur-led businesses, capital management is one problem they would actually like to have.

Young businesses do not generally have huge cash piles. The first few years is usually a hand-to-mouth existence, saving money wherever possible and spending whatever money is available building operations.

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Those that survive can start to think about selecting a finance team to take charge of their capital management. However, most manage without a finance director, instead relying on financial controllers or even book-keepers.

The financial crisis created a double blow for many entrepreneurial businesses – not only did they have to cope with the implications of a sudden drop in demand for their product or service but the credit to support their operations became harder to come by.

Stats Group, an Aberdeen-based engineering business that provides tools for oil and gas companies to isolate sections of their pipelines for testing, had been growing between 50 and 100 per cent in the four years leading up to the collapse of Lehman Brothers in September 2008. In the next year, however, its revenue fell from £16m to £9m, forcing it to cut its headcount from about 140 people to 80.

Although its oil market quickly recovered, Stats, which up until then had been wholly debt funded, faced problems getting the working capital it needed to rebuild its capacity.

“The reality was that it was an awful rock bottom that led us to be very constrained,” Peter Duguid, Stats’ chief executive recalls. “We had to reassess our levels of debt. Certainly, from an entrepreneurial perspective, my focus on the day-to-day management of cash was front and centre.”

Stats recovered its position, rebuilding its workforce to previous levels and returning to strong top-line growth. Revenue this year is expected to be £25m, up from £14m in 2011. However, it has not been easy, Mr Duguid says: “When you are a niche engineering business you need very specialist design experts, so when you let some of those go, it is quite detrimental to the business.”

In March this year, Stats accepted a £7.8m investment from the Business Growth Fund, a bank-financed venture capital fund. The relationship has already produced results, with the BGF helping Stats find a non-executive chairman and finance director to lead the finance team.

It is this support, as much as the funding, that has made the relationship with the BGF worthwhile, Mr Duguid says. “What I see is stronger internal disciplines, stronger accountability in the internal functions of the business and probably stronger banking relationships,” he says. “I have far better visibility [of what is happening in the business] without doing more myself.”

If there has been a benefit from the financial crisis it is that many entrepreneurial businesses have been forced to reassess their reliance on debt and how they manage available capital.

Guy Rigby, head of entrepreneurs at accountancy firm Smith & Williamson, says: “There is an old saying: don’t borrow short to invest long. In practice this means having both fixed capital (also known as equity) and debt in the business.”

The level of debt capacity of a business will depend upon the availability of cash flow to service the interest and capital payments, Mr Rigby notes. “Overdrafts, which are repayable on demand, should be fully fluctuating. In other words the account should swing into credit from time to time and the debt should not be permanently bumping up against the facility.”

He says small businesses are generally not very good at managing banking relationships. “The banks and the businesses are divided by a common language. Entrepreneurs talk vision and the future. Bankers talk cash and now.”

Reliance Fibres, a London-based paper recycling business, trades in seven countries, but gets almost all of its £12m annual revenue from exports to India. As a result, it needs currency hedging support and a large amount of working capital to buy stock. It also needs to ensure that invoices are settled quickly and that suppliers are paid on time.

Good banking support is essential, as is a diligent finance director, according to Pankaj Chowdhary, founder and chief executive. “For us, managing cash is all about rolling it as soon as you can,” he explains. “One thing we make sure of is that we don’t pay anybody up front. We squeeze as much as we can out of our credit limit with suppliers and get as much finance as possible from our buyers.”

Reliance buys its raw materials from large waste management companies, many of them family-owned businesses that are careful about whom they deal with. As a result, Reliance has had to make sure its reputation is exemplary. Being UK-based helps in this regard, Mr Chowdhary notes. It also helps that the business banks with HSBC, which has made Reliance one of the small businesses it promotes. “Reputation is first and foremost for us,” he says.

. . .

While access to finance remains a struggle for many entrepreneurial businesses, alternatives have appeared to enable companies to bypass the banks. Some companies, such as men’s toiletries business King of Shaves and confectionery business Hotel Chocolat, have turned to customers for funding via retail bonds.

The digital age has also created a variety of new business models and technologies that can help them in this process, such as peer-to-peer lending and short-term loans available at the swipe of a smartphone screen.

According to Tony Cohen, head of entrepreneurial business at Deloitte, the accountancy firm, the danger for many young growing businesses is that they get too caught up in the short-term requirements of credit control and so miss out on funding opportunities that could increase their cash balances.

“There is lots of work around creditor terms, cash collection and cash flow, but they are so focused on what they are doing day-to-day that they haven’t the time to think more broadly about where they might be able to get some funds in the future,” he explains.

Larger companies, on the other hand, are inherently better at managing working capital. They also have significant power over smaller businesses they buy from or sell to.

It might seem unfair to those on the receiving end, but it also forces these smaller companies to use their entrepreneurial skills to manage their cash wisely as well as grow their businesses, according to Julian Ramsey, a director at Ernst & Young, the accountancy firm. Smaller businesses should not see themselves as victims. Being small actually has its advantages, he says.

“The most successful entrepreneurial businesses focus on better management of the peripheral – rather than the headline – terms relating to cash in contracts,” he says, “less on whether payment is in 30 or 60 days and more on rebates and payment frequencies.”

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