Getting finance in a recession

Despite the recession firms still need to invest in IT, but gaining finance is harder than ever. In the first part of an exclusive round-up, Joe O’Halloran reports from a roundtable debate hosted by Computer Weekly and Lloyds TSB Corporate Markets investigating the key financial issues affecting the technology industry

Despite the recession firms still need to invest in IT, but gaining finance is harder than ever. In the first part of an exclusive round-up, Joe O’Halloran reports from a roundtable debate hosted by Computer Weekly and Lloyds TSB Corporate Markets investigating the key financial issues affecting the technology industry.

Few businesses have been immune from the effects of the economic downturn. It has increased substantially the operational pressures on companies, through changes in budget, business methodologies and the places in which firms must trade just to stay in business, let alone flourish.

Cuts may be essential, but firms still need to invest in critical areas to remain viable. IT is one such area, and even though IT departments are being charged with doing more with fewer resources, there is a fine balancing act that firms must perform to survive.

Investing in appropriate IT and services can bring about greater productivity, efficiency and flexibility. Getting it right creates opportunities not only for companies themselves, but for their suppliers and, most importantly, their customers.

But how do you go about ensuring you have the capital funding to keep the business running? What is the best way to manage the liquidity of the business while finding resources for key elements such as outsourcing? Basically, what steps should your firm be taking to make sure that it can make investments not just to ensure short-term survival, but to take advantage of opportunities that the economic environment presents, such as expansion, acquisition and cheaper deals on IT services?

Macro-economic factors
First of all, we need to understand how the current economic climate is affecting the investment industry.
Manu Choudhary, associate director at Lloyds TSB Financial Markets, says the forecast from the bank’s economist is for cautious optimism. “We are now into the third month of this equity market rally, and a recent run of better than expected economic data and more resilient confidence numbers have meant that financial markets have shifted away from worrying about how bad the economic downturn is going to be, to looking for when the recovery will start.

“This is a big shift and explains why equity markets have bounced back and why long-term bond yields have risen. Some key commodity prices and currencies are also reflecting this change.”
But is this rally based on sound fundamentals?

“Looking at the market dynamics of March this year, it seems that, for a moment, everyone thought the worst was about to happen. Thankfully, it did not materialise, and we saw a relief rally in the equity markets which, in conjunction with quantitative easing, has helped to instil confidence. As such we are seeing that there is a little bit of a rally in risk.”

Even though the value of sterling has collapsed during the past 12 months, for John Paterson, CEO and founder of Really Simple Systems, the present market offers opportunities in terms of revenues. “The positive side of the exchange rate moving is that UK exporters are much more competitive to overseas marketplaces. So for companies like ours, which have revenues in US dollars and euros, we get more money,” he says.

However, Choudhary believes the US dollar is being sold too aggressively too soon. “The US dollar is well placed to strengthen against its main trading counterparts over the next six to 18 months, primarily reflecting the prospect of a swifter return to economic growth in the US.”

Availability of finance
So what does this mean for UK firms looking to obtain finance for investments in IT? How easy is it to get new funding?

Keith McLagan, lead relationship director for Lloyds TSB Corporate Markets, says, “The freezing up of wholesale credit markets is beginning to improve because of the billions pumped into the economy. But banks are still trying to make sure their business models work where they have historically lent long against short-term deposits and borrowed the difference in the wholesale markets. It is unlikely that, going forward, a bank will want to be too dependent on the wholesale markets – Northern Rock taught us all the dangers of that business model.

“Against that background, along with the general economics of a recession, lots of companies understand that they need to reduce their leverage. That is important for companies that are refinancing or looking for credit when it comes to how comfortable banks will be with what is being requested. Carefully considered business plans by management at reasonable leverage levels against good visibility of income will still be successful in obtaining the finance required.

“Another point is the cost of credit which has been widely reported. The real cost is no more than it was 12 months ago, due to the fall in interest rates. But anyone refinancing at the moment will have seen that margins have increased due to the banks’ needs to cover their increased cost of capital caused by the freezing of the wholesale markets.”

The right business
Lloyds TSB says it has the right money for the right business, but what constitutes “the right business”?
McLagan explains, “In the IT sector, as with all sectors, this means management having a clear strategy for what they are trying to do with their business and being able to execute that strategy. That is management both at CEO level and across the whole board. If anyone were to go into their bank at the moment they would have to make sure that the historic numbers are available and the management numbers are absolutely up to date, fully understood and acted upon accordingly.

“Eighteen months ago it would have been easier to have plans that were less well defined because of the amount of liquidity that was available. Today, the world has changed and we are looking at much lower leveraged businesses that we are prepared to lend to, while challenging and discussing their strategies along with issues such as deliverability.

“Ideally, if they can show experience within the company, they might get a better hearing from their bank. A few more grey hairs in boardroom can help.”

Predictability of revenues is another key element in gaining finance, says Martin Leuw, group CEO at IRIS Software and Services. “We sell software to SMEs on a rental basis and so we have the benefit of providing software to our customers in a very cost-effective way because they are paying over a long period. In terms of raising finance, it helps because we can show predictable high levels of regular income which underpin the business. This can be key in swinging the deal.”

McLagan agrees, and outlines other key factors that he will be looking for. “The ideal mix from a banking perspective is where you have good visibility of income coupled with predictability in the business model and where the software can be described as business-critical for customers.”

One thing that all the delegates were in agreement with was that companies should not change their business model to attract investment. All agree that the business model has to address the needs of customers, not bankers, who in any case will be looking for evidence of customer focus in the firms they invest in.

Support from suppliers
The roundtable delegates who supply software are keen to help customers justify investment in IT and help them gain investment from banks.

Toby Davidson, director of professional services, EMEA at NetSuite relates his new way of working. “We have to justify the investment to customers. Our ERP systems are business-critical applications and the message around funding is stronger, but we are seeing that the process of achieving funding [for end-users] is much longer and the pool of lenders to companies is smaller.

“We have reached the point where we work closely with lenders and in effect take our potential customers to lenders where previously we would have left that to end customers to use whatever method they chose.”

Similarly, Paterson describes how his software engages in this practice. “We deal with [users] who are finding it very difficult to roll over existing [investment] facilities and are being offered deals that are extremely unattractive. My advice is that in the same way that banks are being brutal to you – both in terms of reducing facilities and opening up the margins and upping fees – you have to be the same with the banks.

“You just cannot rely on the local branch that you used to know and had a personal relationship with. You have to shop around and find one that likes your business.”

Asset financing
Hilary Weatherstone, director of technology at Lloyds TSB Asset Finance, offers some suggestions as to what those seeking investment in IT should do to become a suitable candidate for credit and, in particular, asset financing.

"First of all, the smart companies, of all sizes, speak to their bank early on. They have all the right information with them, they are straight with their bankers and they get real about what their business is like.
“From a borrower’s perspective, if they go to a bank, they should be thinking ‘what are all the different things that this bank can do for me, and therefore what type of business should I be putting to the bank?’ This allows both parties to look at ways of building a mutually beneficial relationship.

“This relationship aspect of banking is key. Understanding the sector makes a huge difference: it saves time and makes sure that you have much more sensible discussions. Find a champion who you can trust. Share your strategy and your business plan with them, and talk to the bank’s product specialists, who can find ways to support your growth. You have to think longer about the long term and it is a good idea to have two or three banks providing what you need to give additional flexibility and breadth of financing.”

New lines of finance
Some delegates are finding that their traditional lines of finance are drying up. Speaking as someone who looked to finance houses when he set up a new datacentre, Martin Batterberry CFO, UK & Ireland at Bull, advises against relying solely on existing financial suppliers to carry on investing. You may have to break new ground in gaining finance, and to do this a sound plan is everything, otherwise you may have to draw upon cash reserves – something he cautions against.

“Our group is cash rich, but some of the cash goes to other places, so we [have to find finance] and the business case needs to stack up. We had a pool of leasing organisations to use and one of them had the attitude that we were maxed out and any new lending would cost more. Our business case has to be stacked around the long term, and even if one bank wasn’t able to renew, other banks listened to our message and saw that the business case stacked up.

“Rather than draw on company cash reserves, we took revenues over a longer period, and the balance sheet reflects that.”

The recession has also cut down the timescale in which customers expect IT to deliver a return, and this makes the decision making, and hence investment, process even more critical.

That said, the general consensus was that bankers and suppliers are seeing resilience in IT as it can be used to adapt end-users’ business models to cope with today’s exceptional economic circumstances.

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