Specialist Funding products - Trade finance

Following on from my tongue-in-cheek review of business funding products, my aim now is to flesh out some of the less understood products; in this case Trade Finance.

If you ask most accountants, bank managers or business advisors about trade finance, in 80% of cases you will be met with one of 2 responses: either a blank look, or something along the lines of 'Oh yes, thats for stocks and things' - test me on that one!

So to dispel the myth (and alienate half of my readers): Trade finance is not stock finance. Stock finance per se does not exist (but if it did, I'd be very, very wealthy - at least for a short time).

Having established what it isn't - what is it? and who can use it?

Trade Finance is a specialised funding product which is probably appropriate for about 10% of businesses in the UK - and for those companies it really can be the difference between run away success and limping along from day to day.

The vital components to create a trade finance deal are:

1. Finished goods (or simple process required to finish)
2  Confirmed order or clear route to sale.
3. Credit insurance on one of the key parties.

So in the most simplistic of scenarios  XYZ inports supplies SpaceHoppers to a varietly of local stores. They are sourced in China & shipped direct at a gross margin of 30%

They are approached by a major multiple who wants SpaceHoppers supplied in bulk, potentially trebbling their turnover. XYZ approach their bank for an overdraft to fund this transaction for 60 days; unsurprisingly the bank decline as there is no tangible security in the UK.

 Enter Trade Finance. The trade financier effectively takes on the transaction on XYZ's behalf buying SpaceHoppers and delivering for a fixed fee.

Result:

The customer fulfills his order and is now established as a regular supplier to that multiple (and a valued customer of the Chinese manufacturer)

The multiple has their stock in good time and on standard terms.

The bank have a secure customer without having taken any risk (The trade financier is independent so the banking relationship remains intact).

That is, of course, a perfect world scenario, there are often a lot of twists and turns and varients on how the product is offered.

Traditionally, this is an area where banks would have taken a punt on overdraft funding (often dressed up as trade finance), but that is now extremely unlikely - in fact it would probably be an instant-dismissal offence for most managers to take on this type of facility.

In a nutshell, trade finance is about getting the deal done; in the example cited, the customer had a clear choice - do the deal with trade finance or lose the customer.

Those who can use it really need to be aware of this product.

EFG Loans - Who has been conned?

Back in January 2009, the (then) Government announced, to great fanfare, the EFG - Enterprise Finance Guarantee - loan facility.

In a nutshell, the Government would provide a 75% guarantee on loans to those businesses who were struggling to raise finance for cashflow or growth.

Like most Government initiatives, the underlying intention was good, but by the time it came to fruition it was mired in so much red tape and so many caveats as to render it effectively unfit for purpose.

A liberal thinker might suggest that the Government are just too distant from business to really understand - whereas a true cynic would say that it was just another attempt to appear to be doing something good whilst passing the responsibility elsewhere - in this case back to the banks.

To look at some highlights

The scheme is aimed at successful businesses which are experiencing difficulty in raising finance. This is the eternal lending conundrum; in every single proposal we see, the business is doing well, but just need a few months to... (it has been said that in every liquidation the directors still believe that they only needed 3 months to sort things out). Of course, many of them will survive, but equally many won't. Sadly, both banks and Government have shown themselves to be fairly inept when making these judgements.

The original scheme was for £600 Million - now extended to £2 billion.  This means that we are asking our failed banks to commit to £1/2 billion of debt they are not entirely comfortable with. Shortly after they have lost billions by imprudent lending..


Banks are allowed to take security, but not over the family home: In lending circles, it is implicit when seeking additional security that you are not entirely comfortable with the primary debt. In reality due to the numerous caveats on the scheme most banks are seeking 100% security whilst using the guarantee as a fall-back.

So far, so good, what exists is basically a very confused view of what constitutes good credit and security - hardly surprising when you consider that no one in Government (any party) has any involvement in business.

However - there is a sting in the tail.

Paperwork: Who has had to fill in Government forms? All of us. Who has had forms returned due to insignificant input errors? Many of us. Who has gone on to be fined for late filing after forms have been returned? A few of us.
Just because this scheme is dressed as a collaboration between Government & banks doesn't exempt it from the confetti factory that is Government paperwork. It is reported that Barclays lost millions under the previous SFLG scheme (which the EFG replaced) due to paperwork inaccuracies. OK, the banks should get it right, but the Government should also honour the spirit rather than the letter of the agreement. (They are not exactly immune from errors themselves).

Bad debt: The very crux of the matter! successful lending isn't about putting money out of the door, it is about recovering it. We have established that there is a lack of clarity in this framework over what constitutes good credit. To protect you, the tax payer, the Government have set a ceiling on what they will repay under the scheme - this is set at 13% of the total loan portfolio (in other words 9.75% of the guarantee amount). To put this in perspective, there were reports of bad debt running as high as 60% under the SFLG scheme which would have put huge debts back on the bank.

The dual rationale for this is:

1. To make sure that the banks lend responsibly.
2. To protect the taxpayer.

All well and good, but various ministers are still banging on about 'forcing banks to lend', which doesn't sit neatly with a prudent policy. It's nice to protect the taxpayer, but it's not really a guarantee, is it?

Just once, wouldn't it be nice if our Government actually did what they promised rather than hiding behind paperwork and rhetoric?

Umbrellas in the sunshine

Do you remember in the not so distant past when raising money for your business was relatively straight forward? You called your bank manager and he/she visited you. You presented them with accounts and projections and they granted you a loan or overdraft on a sort of sliding scale:

·         If they were very confident they would grant a facility on the figures provided.

·         If they were cautiously confident they would take a charge on business assets.

·         If they were a bit concerned they would take personal guarantees

·         If they were worried, they would take a second charge on your home.

In most cases the business owner would trundle along to their lawyer comfortable in the knowledge that the promised loan would repay the mortgage several times, plus their house was appreciating in value so - at worst - they would still have equity with which to repay

Then, way back in 2008, the bank realised they had got it wrong. Oh, so very wrong.

At almost every level.

Mostly, the good stuff was good; but the charges on assets were undermined by a small but crucial Court ruling which excluded book debts (pick me up on this, it’s just an overview).

When it came to taking charges on family homes, they were undermined by several factors:

1.       They had ignored the fundamental economic reality that property is a commodity, and values can go down as well as up.

2.       When push comes to shove, people won’t give up their home without a fight.

3.       That wholesale repossession would wreck their balance sheet and

4.       They could never have foreseen that they would become effectively State-owned, and their new owners would never countenance the removal of families (not living considerably above their requirements) from the family home.

This, of course, is exceptionally good news for those business-owners in considerable difficulty facing potential bankruptcy and possible eviction.

Unfortunately it is very bad news for those who have spent decades paying down a mortgage and now, in need of reprieve, are faced with a straight decline for borrowing facilities.

What this means is that the canny business owner, who has kept an overdraft in reserve for the proverbial rainy day, having reached that rainy day, hasn’t just seen the facility withdrawn for lack of utilisation, he can’t renew it even though he is offering the ultimate security. To go back in time, this is the old analogy of banking – that they will freely hand out umbrellas when the sun is shining, but take them away when it start to rain.

So, is there good news? Well, in a limited way.

Firstly, there are, of course more relevant ways of borrowing money than bank loan or overdraft such as hp/leasing, sale and lease-back, factoring, trade finance, crowd-funding, equity investment  etc. secondly. There are lenders who will still lend on a second charge but – be warned – they will not be as slack as the banks and will look seriously at the proposal! and will expect to enforce their security if things go pear-shaped.

It’s not all bleak, but it is important to keep realistic expectations!