Adapting to the needs of SMEs: financing – with services too
From its creation to its handover to others, by way of the phases of organic and external growth, the development of a company depends on solutions making use of financial techniques.
The solutions that banks can offer to companies must take into account their specific characteristics, sectors of activity and capital structure, and also the patrimonial concerns of the owner. All companies have the same need to find the capital that will enable them to start up and grow. The utility of the bank, and the banker’s fundamental role, lie in their ability to offer company managers solutions adapted to their situations, in terms both of financing and, going beyond that, of associated services and advice.
Banks have become true integrators and assemblers of solutions relating to different items on the balance sheets of SMEs. Traditional financing systems (which mainly impact the debt section of the balance sheet) remain the principal mode of financing, either by means of classical investment credits (for equipment, real estate, MT credit or leasing), working capital financing (overdraft, bank discount…), or international financing (mobilization of foreign debts, documentary credit, exchange risk coverage).
Today banks are also in a position to offer their corporate clients added value services: as well as financing they provide added security or business development opportunities. For example: as well as factoring functions (debt transfer and recovery), banks offer out-sourced services for SMEs, particularly for financing, insurance and management of trade receivables, or help in prospecting for potential new clients and suppliers and setting up subsidiaries in the major high-potential world markets.
During the last decade, merchant banking activities, grouped under the term “equity financing”, have come to play a larger part in the relationship between banks and companies. Capital investment solutions (intervention in equity and quasi-equity capital) offer useful complements to leveraged debt financing. SMEs in fact need “patient capital” that avoids dilution of the shareholder base, and this implies the presence of partners able to offer long-term support.
Diagnosis, advice, search for purchasers or take-over targets, creation of contacts, asset engineering, private management – the whole range of banking specialties can be involved in these equity financing operations. To respond to companies’ needs while complying with the prudential constraints of Basel III, banks can propose alternative or complementary modes of financing. They can support their clients in the bond market. Bond issues are becoming more frequent, and not only for large companies. Finally banks can offer effective support to dynamic SMEs that wish to go public. Today the stock market is an option only for SMEs that are already of significant size, but things may change: on May 23rd NYSE EURONEXT launched a new market dedicated to small and medium-sized enterprises.
Banks’ ambition is to offer a global, innovative and individualized response to the financing needs of companies, close at hand.
Companies: how to develop while increasing their capital!
The growth of an enterprise may sometimes absorb a great deal of capital, making it necessary to strengthen the company's equity.
A company's first source of finance, its own operating cash-flow, may be insufficient to finance its growth if this requires significant investment in fixed assets or involves a substantial Working Capital Requirement.
Equity capital can be increased in several ways:
* Incorporation of currrent accounts and personal contributions
This is the simplest type of operation: the shareholder(s) of the enterprise make a personal contribution to the capital. This contribution may take the form of a bank loan (mortgage on property, pledging of assets, etc.). The operation may be accompanied by incorporation of partners' current accounts, if any, so as to strengthen the financial structure of the company and consequently increase its borrowing capacity. Such operations can be implemented quickly but are limited in scope by the level of personal debt that can be supported by the shareholder(s).
* Opening up of capital to a private equity fund
If a personal contribution is not enough, the entrepreneur may decide to open up his capital to a private equity fund. In this way one or several investors will acquire a holding in the capital of the company, depending on the funds they contribute. They will be remunerated by the payment of dividends and also by capital gains made when they sell their shares.
Different categories of investment can be distinguished, depending on the stage of development of the company:
- seed capital funds, which traditionally intervene a long way upstream, sometimes when the company is founded or when it starts to develop its technology;
- venture capital funds, used when the company has finished the development of its products and receives its first orders;
- capital development funds, restricted to fairly mature companies that already have substantial sales and are profitable, and that wish to increase their market share by increasing production capacity and/or by developing internationally.
Finally, when a company is bought out, other investment funds may be involved: these are known as LBO funds (Leveraged Buy-Out). This technique can be used to take over a company using financial leverage (combining a bank loan with equity contribution), through a specially-created holding company. These funds are aimed at mature companies positioned in steadily growing markets and with good financial visibility.
* Initial Public Offering
The Stock Exchange offers companies access to a permanent source of funding, enhanced recognition and improved visibility for investors.
The company has access to a permanent source of funding. Flotation on the financial markets is often an opportunity for an increase in capital designed to strengthen the financial structure of a company and fund its growth. An operation of this sort entails no repayment since it increases equity and thereby reduces the need for debt financing. An increase in capital can also be repeated whenever the need becomes apparent.
Once listed, the company can mint its own money: its shares in fact represent a negotiable currency. In order to finance external growth, a company can not only resort to debt or use its cash reserves but also make acquisitions by exchange of shares.
Flotation on the stock market facilitates the transmission of a company: succession within a family, sale to a third party, progressive withdrawal from capital ... The owner-manager can in fact sell shares on the market at the rate he or she desires.
The stock market enhances the company's credibility thanks to financial information and undertakings for the future. Listing on the stock exchange is a quality label, attesting to a company's dynamism.