Engineering
Engineering companies are struggling to connect with sources of finance. Plus, a round table gathering of industry experts.
Reversed engineering
The banks and lending institutions are awash with cash. So why, asks andrew macleod, is the beleaguered engineering sector finding it so hard to fund growth?
IThe wannabe young again boom - epitomised by businesses like Friends Reunited and School Disco - is playing an increasing role in the UK's commercial make-up.
While a significant sector of still-affluent Britain gets togged up in its St Trinian's best and parties its way towards the take-your-pick array of crises looming over the horizon (stock market at a seven year low, oil prices going through the roof - oh! and the small question of a war), the nostalgic throb of 1980s music from the dancefloor drowns out the cries of pain from the engineering sector.
Try to refinance an engineering company, on the other hand, and all eye contact ceases.
"Nobody's eyes light up when you tell them you're in engineering. It's not a glamour industry," says Fred Mead, manager of the Leicestershire branch of the Engineering Forum - an organisation representing the interests of small and medium-sized firms in the county.
"Because of that, finance is difficult in a number of ways. Banks might be willing to give you a business loan or permit an overdraft - but only in return for security. Without freehold property - or at least a substantial balance sheet - you're unlikely to get anything unless you put your home on the line.
"On the other hand VCs have very high expectations, and want high growth rates and evidence of new products.
"They also want more equity than most firms are comfortable with, and very often their goals are not the same as yours."
The third whammy comes when engineers in the SME sector (companies employing fewer than 250 people and turning over less than £340m euros) turn to debt factoring to increase their cash flow.
"If you have a small number of customers with high individual accounts, factoring can cause all sorts of problems," says Mead who says factors prefer to handle a large number of small invoices to a small number of large ones.
"Debts around the £350,000 mark are often excluded from the process," he adds. "It's a difficult world out there, and engineering firms know that if they want to grow they often have to do it slowly, using their own resources."
It seems that for every example like that of Dudley-based Machined Fabrications, which recently bought a £3350,000 gantry milling machine with finance from Lloyds TSB Corporate, there is a counter-story.
Peter Matthews, chairman of the Midlands World Trade Forum and a spokesman for the Chamber of Commerce movement in Birmingham and the Black Country, responds: "We have member companies who have secured orders, supported by letters of credit, but are finding it extremely difficult to get finance, not just from the banks, but also from the agencies that are supposed to help them.
"Without that help they can't meet the orders, and that hits exports for the region as well as the individual companies concerned. Support is needed to help these firms to upgrade plant and to buy the raw materials they need."
Matthews adds: "Some of the cases we have handled have been incredible. In one instance a company with exports amounting to millions of pounds to the US had its insurance export credit withdrawn.
"It was only restored after we took the case to the press, and the facts were made public."
James Bentley is director of the Manufacturing Foundation, a Midlands-based UK think-tank that conducts extensive research in collaboration with a range of industry partners.
His findings seems to show that there is a dearth of investment opportunities in the £35m-plus bracket which is traditionally the venture capitalists' hunting ground - although it might be reasonable for an outsider to infer that the real shortage is in the supply of suitable companies, rather than reduced demand. Potential investors are definitely pickier about where their money goes.
Bentley argues that because there are fewer opportunities, VCs are now lowering their sights, targeting deals they would previously have considered small fry.
This still leaves a gap, he says, between the business angels' domain - the £310,000 to £3100,000 bracket - and the £3500,000 mark below which not even the most desperate VC would venture.
It's Bentley's case that banks, with a long view of investment, remain a good source of cash, if they can be persuaded to part with it, because unlike VCs they are not looking to sweat their equity with a three-to-five year exit in mind.
"But there are other ways of freeing up capital from a business," says Bentley. "Most companies and their advisers are now pretty smart when it comes to leasing premises and capital equipment, rather than buying it outright, for example. And there are more traditional ways of freeing up cash for investment."
In order to liberate the funds they need, he urges executives to raise their gaze from the shop floor, and illustrates his case with research from his own organisation indicating that leadership is the major factor in the success of companies.
"We conducted 30 case studies of businesses turning over £3100,000 or more per employee, and in each case found that it was the quality of leadership that marked out the most successful," he observes.
"The leaders of the less successful companies complained they didn't have time to think strategically or engage with their customers. Leaders of companies where workers were empowered to take decisions themselves made the time - and a firm with a strategy has less trouble raising the finance it needs."
Listen to Ian Smith, recently appointed chief executive of the West Midlands branch of the Engineering Employers' Federation, and locating pots of cash isn't a problem. Just tune in to the Advantage West Midlands website, he says.
There you will find an astounding 550 sources of capital for cash-starved firms - including a new £320m regional venture capital fund, whose aim is to invest up to £3250,000 a time in West Midlands companies.
The sting in the tail is that an advanced degree in reading the runes is often required to get through the maze.
"Unless companies are actually led through the process, they find it extremely difficult, and just give up," says Smith. An entire industry of financial sherpas has grown around this world of endless form-filling, but he counsels business people to be wary.
"There's a whole host of agencies out there - but watch out for the ones that just want to plonk an idea on your desk, talk about it for 20 minutes, and then leave you with the forms," he warns.
Smith believes the application paperwork for grants and cheap loans, which is based on the lingua franca of government - unintelligible Sir Humphrey-speak - should be made simpler and more accessible to ordinary business people.
Nevertheless, the AWM site (www.access2finance.com) is a useful starting point, he insists, and his view is underlined by AWM business finance executive Mike Watts, who explains: "The Advantage Growth Fund is intended to plug gaps in commercial sources of funding, and it recognises that it is difficult to obtain relatively small levels of equity finance.
"Having said that, it is being run as a commercial VCT, so the fund manager will be looking for good investments that will provide a return."
Watts, who points to other sources of funding like grant aid, says AWM's next step will be to establish an early-growth fund, to provide equity investment at an even lower level.
The Advantage Growth Fund, launched in February, is managed by John O'Neil at MidVen, who brings years of experience to the process, and has already dipped his toe in the water with a couple of investments.
"I have seen the economy go through boom and bust a number of times over the years, and have now come to accept that the best course is to invest when the opportunity arises, without getting too concerned about the economy in general," says O'Neil.
"The government is helping to establish funds like this which will invest in small and medium-sized businesses as the larger VCs move to higher ground and bigger investments."
Jonathan Lowe, head of business investment at East Midlands Development Agency (EMDA), regrets but accepts that engineering is not regarded as a growth sector and therefore struggles to raise the money it needs for expansion.
His experience is that venture capitalists have raised the bar, and are now not really interested in any deal of less than £35m. Nor do they see engineering as a sector they are keen to get into.
This leaves a substantial void between the £35m VC threshold and the average £337,000 provided by business angels in a company's early stages.
Because of its mining past, the East Midlands benefits from special grants under the regional selective assistance (RSA) scheme, and significant help is given to engineering business in the former coalfields of Nottinghamshire and Derbyshire.
"The emphasis is on the creation and safeguarding of jobs," says Lowe. "The West Midlands will have a similar programme in its region, and the grants give us the opportunity to help growing companies in the designated areas.
"There's a lot going on in the area of finance, and it's not just about government grants," he adds. "We try to promote alternative ways of financing, where the public sector steps in to stimulate activity in a way that makes a difference."
He has in mind the creation of an early growth fund, willing and able to make investments of between £325,000 and £3100,000 - "the level that a traditional VC would not even consider, but which can provide real stimulus to a company's growth."
Andrew Raca, corporate finance team director with business advisers Ernst & Young also knows there is cash in the system, and has advice for companies wanting to get their hands on some of it.
"When we speak to the banks they tell us that they want to lend - and we know that they need to lend. Because so many people have got out of equities and into the banks, there is a lot of money out there."
But engineering firms in search of cash should not make their pitch to a bank as they would to a VC, he says.
"The best approach is to take a realistic line. Present a good business plan that shows them they will get their money back. A bank wants the reassurance of reliability," says Raca.
Where expansion involves an acquisition, due diligence should be conducted with the most exacting precision - and firms should be cautious about inflating forecast earnings.
Few things deter lenders more than profit warnings, and Raca points out that we are now entering the warning season for companies whose year ended in December.
Profit warnings are nature's laxative for fund managers, and in Raca's view they establish the mood for the way banks view industry. "They make lenders extra cautious, and seek additional comfort from the due diligence process.
"A company that wants to borrow money should prepare itself - make sure its case is robust, that it can withstand close scrutiny, and that it has answers to all of the questions that a bank will inevitably ask. That is where financial advisers can add value."
The whole issue of finance for industry has been exercising Ernst & Young in recent times. It has put together a document examining private investment in public equities and setting out the reasons why the concept in Britain lags so far behind what is happening in the US.
Explains Raca: "It's a way private equity investors can invest in quoted companies, and is a further way to reach venture capitalists who have a lot of money to invest."
Alan Ward, head of the corporate finance team for BDO Stoy Hayward in the Midlands, underlines the dilemma facing small engineering firms - that asset-rich large firms find it easier to borrow £310m than companies seeking just £3100,000 or less.
Bob Hale, chairman of the RSM Robson Rhodes national engineering group, believes the term "asset-rich" can often be interpreted as non-core business whose value can be released through disposal and spent in more strategic ways.
"The concept of carrying freehold property as a secure asset to enhance bank lending is now an outdated misconception," he comments.
"Unless you are a property company, little advantage is gained from having substantial property fixed assets on the balance sheet, when these could sensibly be realised and the proceeds invested in research and development and hi-tech plant to develop value added manufacturing capability.
"Also the stigma attached to debt factoring has long since gone and this method of finance should always be explored by businesses as a way of maximising their working capital availability."
Back to Ward, however, with a reminder that an alternative to straightforward borrowing has always been an injection of capital from a venture capitalist.
First find your VC. And remember that no matter how understanding he appears, he will want to exit in three to five years - raising the prospect of a secondary buy-in, perhaps by a less sympathetic investor.
Ward observes that the current difficulties have encouraged a new form of buyout activity - the vendor-backed MBO. This allows an owner-manager to exit his business even when conventional funding is not available by lending the buyout team a large part of the transaction figure.
"If a company is sold for £310m , the vendor ploughs a large sum - say £39m - straight back into the business. He has £31m in his hand, and a better return on his remaining £39m than he could get elsewhere," according to Ward.
And then there's outsourcing, says David Hull, head of corporate in the Birmingham office of Hammonds. "At the moment many companies are busy trying to survive from day to day, and are finding even that difficult," says Hull.
"There is a lot of outsourcing of both services and manufacturing, which frees up resources, and a lot of asset finance-backed deals. Unfortunately I can't see any blue sky on the horizon at the moment.
"But on the other hand, if, as a lot of commentators believe, we have reached the bottom of the cycle, now might be the ideal time to be putting deals together, because values are so low," Hull adds.
Case study Tsubakimoto
assistance from the regional development agency in finding a grant helped an engineering firm stay in the uk.
In common with other regional development agencies, the East Midlands Development Agency (EMDA) offers financial support and practical assistance to companies in its area of operations.
One firm which has benefited from this help recently is Tsubakimoto, an international company manufacturing roller chains and power transmission products, which obtained a £390,000 regional selective assistance (RSA) grant - with EMDA's assistance - to relocate from Bingham to Annesley, Nottinghamshire, in 1999.
The firm now employs 40 full-time workers at its Annesley plant, as well as a handful of part-timers, and is in the process of putting together another grant application to help fund further growth.
Managing director Bart Mellink says: "Tsubakimoto had the choice of investing in Holland, or in a new purpose-built facility in the UK.
"In order to qualify for the RSA grant we had to show that without the assistance the factory would probably have been built elsewhere, which we were able to do. The fact that we were awarded the grant helped us to make our case with the Japanese head office for staying in the UK."
Jonathan Lowe, EMDA's head of business investment explains: "Although we help where we can, it is fair to say that the majority of people who apply for these grants use their own accountants and advisers to put their applications together.
"It can be a complex web."
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