The creditors’ dilemma  

The role lenders play in enabling SMEs to achieve their potential cannot be overstated. Without their timely and strategic injections of capital, companies would neither be able to get off the ground nor have the necessary funding to grow, expand and invest.

Moreover, with KYC requirements and covenants, lenders play an invaluable role in keeping SMEs on track and focussed on their primary business objectives.

Simon Fry, Partner at ReSolve, the business advisory and restructuring house, said: When a lender is satisfied with its due diligence and signs a loan facility, it is in good faith that the SME it has invested in will achieve what it has set out to do. However, there are extenuating circumstances that can interrupt a business’s trajectory – and COVID-19 is an obvious culprit. The pandemic and ensuing economic uncertainty have rocked many SMEs, leaving them in an unexpectedly difficult position with a weak balance sheet, dwindling cash, unsold stock, idle equipment and furloughed staff.

Whilst the popular image of a lender is that of powerful mainstream banking institutions, overflowing with cash, the reality is more nuanced. Lenders can also be SME specialists, co-operatives, or alternative lenders involved in peer-to-peer lending, invoice financing or crowdfunding. COVID-19 will also have stretched their balance sheets due to liabilities and overhead costs of their own, as well as capital requirements.

When it comes to clients that are not honouring their repayment terms, lenders have but two options – take an aggressive stance and extract cash by all means necessary or work together to find a way forward.

Even at the best of times, aggression is rarely seen as the best option. Not only will it likely ruin the relationship with the client, but it can also affect a lender’s reputation within the sector leading to fewer businesses willing and wanting to do business with it. At ReSolve, we work with companies dealing with financial distress as well as their financial stakeholders (including creditors, banks, landlords, suppliers and investors) and our advice is generally to avoid taking an aggressive stance unless all other options have been exhausted. It is our experience that an overly adversarial approach by lenders usually goes nowhere – except perhaps the courtroom.

What generally works better is working together. When a more collaborative and trusting approach is taken, with more options made available, we find that there is a better chance of reaching an outcome which all parties can live with.

If a client is facing financial stress, the first step for a lender should be to assure them that every attempt will be made to find a solution that works for all parties. To do this the lender will need to undertake a forensic examination of the company’s financials to see how it is faring – especially in relation to incoming and outgoing cash flow as well as identifying how much is tied up in inventory, current and non-current assets, and liabilities. The lender will also want to elicit a clear and honest view of current and future trading. Under normal circumstances this request is relatively simple; however, due to the unpredictability caused by COVID-19, it is now often more difficult to get a good view of trading forecasts. Therefore, our suggestion is to assume the current level of COVID-19 restrictions, and therefore constrained trading levels, will last for at least the next six months.

Once this review has been completed, it is also important for the lender to give its opinion on the most effective way to strengthen the balance sheet and optimise cash flow or at least conserve cash. If the business is a large one with multiple divisions, a discussion about the potential for disposals should also be had.

If there is trust and goodwill between both parties, this conversation should be a productive one. It is important to reiterate that a non-zero-sum solution is being sought.

Another necessary step is to find out if the company is paying its other lenders and on what terms. This will be evident from reviewing the company’s books, but a conversation is also necessary, especially if there is a divergence between the terms the owners are offering different parties. While we stress that being supportive is best, it’s also important to not be the only one taking the brunt, so try to have an honest conversation with all stakeholders in a way which will not compromise your own position.

It goes without saying that lenders must not forget about their own liabilities. Before accepting any new terms, each lender must consider its own financial situation and be realistic about what is feasible. Accepting terms that don’t work with the lender’s parameters is self-defeating and ultimately will be detrimental to all parties, including the client you are trying to support.

The simplest ideas are often the best. None of the above can be achieved if the initial phone call to check in with the client isn’t made. Whilst it’s always easy to avoid a potentially difficult conversation, any issues will only become more intractable with time. Having honest conversations early and often can save you and your client from losing out.

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