Owner Managed Businesses: surviving a difficult market

Entrepreneurial owner managed businesses (OMBs) are important. They provide more than 50% of UK plc’s turnover. So how are they faring in our new age of austerity? The Business Magazine, assisted by chartered accountants and business advisers Wilkins Kennedy, gathered a Roundtable of local business professionals to find out. John Burbedge reports the highlights of their discussionBanker Andrew Brattesani: “There are different views in different market sectors, but generally I’m feeling very upbeat. Last year, out of 1,400 Thames Valley customers, only four failed, which is quite a result. Talking to my colleagues that has not been replicated elsewhere so I am seeing more north-south divide than ever before. Our lending was 100% up last year, we all hit our bank lending targets, but it’s noticeable that customer confidence appears less than 12 months ago and if one thing scares me then that is it.”

Robin Goddard:  “Handling factored invoicing, we get an easy steer to the market place. We’ve seen a downturn in the value of invoices factored by our clients, which means our clients’ turnover has fallen. However, we’ve not seen a massive amount of business failures.

“Confidence is the word on the street. Things are OK at the moment. As long as interest rates don’t change too much, and nothing drastic happens, then businesses are looking to pull through the next 12-18 months. It’s all about survival. A few have massive growth projections over the next two years but most people are thinking that if they can do the same as they have so far then they will have a good year – still making a little money, but reducing debts, not borrowing for new equipment. The mood is: We’ll sit with what we’ve got and sweat the assets.”

Brattesani said the continuing Eurozone financial problems were also affecting UK business confidence.

Goddard:  “It’s all the unknown quantities. What’s the next step from the HMRC? Time to Pay, and PAYE arrangements, for instance?”

Ian Ross: “A lot of businesses are just sitting on what they have got and some are actually in a comfortable position. They’ve had three years of cost saving but there’s a limit to what they can do now, so they are making a small profit, and watching for opportunities.”

Paul Hinder: “Opportunities can have an upside and a downside and at the moment no-one wants to do anything risky. People are just staying where they are, and getting through it.”

Stephen Holt: “Some have a pile of cash in the bank, but are just not doing anything with it.

Do you want some money?

David Murray asked: “So how do we encourage entrepreneurial risk-taking, and funding for growth? How do we start the UK recovery? Or is there a lack of will to borrow to finance growth aspirations?”

Brattesani pointed out that his major cash-holding ratio had risen from 3:1 to 4:1. “I am carrying too much cash and we are trying all we can to get people to seek funding, even to the extent of asking: ‘Do you want some money?’”

Matt Hall suggested one potential driver for growth was research and development, supported by R&D tax credits from the Government. “If you are bringing something new to the market you will get results from that. Two companies I deal with have taken that route and for the past three years have doubled their profits year on year.”

Be positive. Don’t believe what you read in the papers!

Trevor Wilson: “How much does the media affect us? If the media tells people things are terrible then they are going to hold on to their cash. If it says things are great then perhaps they’ll start investing again.”

Jim Bailey: “It is all in the mind. If we send out positive messages then people start talking positively, and off things will go.”

Hinder: “I was worried about Europe in late 2011 when it was front page news so should I be less worried today because there’s less about it in the papers? I personally think it’s still bad but its not Armageddon.”

The best advice is not to read the nationals, the Roundtable suggested.

Solicitor Ian Wood-Smith agreed businesses were hanging on to their cash, but the image-bashing of professional sectors (particularly bankers) was not helping confidence in loans for growth. The number of corporate finance lawyers in the Reading area had significantly reduced in the past three years, he said. “They are going back to core business, because the deals are not there.”

Hall didn’t totally agree. He had recently acted in two deals of close to £50 million each. “I do have a few businesses that are growing quite massively and excitingly.”

“Those taking the risks, and not believing the Press, are actually finding some good results, but it takes a brave business to do it because no-one wants to make a mistake right now.”

Brave new worlds….

Together Mark Truswell and Natalie Barker had begun two businesses. The first, promoting green energy, was started in 2005 and funded by themselves, a £100,000 small firms loan guarantee and some VC support. “It was very difficult to get finance then, and I would not be optimistic about getting the same funding today,” said Barker.

They funded their second business by selling the first and “burning the funds on the second”. Learning from their first business experience they changed from a CapEx to a revenue business model when co-founding cloudNETZ, which designs, builds and hosts cloud computing applications.

“We decided we wanted a business where we could outsource the capital risks. So, we don’t have any hardware, and instead we have contracts in place with leading data centres and various managed services,” said Truswell.

Barker: “Our previous business was project-based, asking customers to invest £200,000 in green technologies, whereas now we ask them to pay £60-140 per month for a usage licence for cloud applications.”

Are you from the north?

Murray asked Truswell if development of the ‘green’ business was supported by government grants. “No” said Truswell. “There was a lot of talk, it was a hot business field, but we got nothing.”

Bailey asked if that was because you are based in the prosperous south east. In the regions there are grants available for new business ventures.

Truswell replied: “So, let’s narrow down the socio-economic band of the people who could become entrepreneurs: You can’t be trapped in debt, have to have certain skillsets and a reasonable education, and you’ve got to be able to present a business case to a bank or VC.  It’s already a fairly narrow band …  and now I have to be from the north?” he queried. “I’ve nothing against Newcastle, but you have to invest in those people who can make it happen, wherever they are.”

The £1 million question . . . and the need for seed

Barker: “Once you reach £1m turnover, finance options open up. Up till then, you need to fund the business yourself because you can’t find seed funding for new businesses.”

Wilson said too often young businesses presented their business proposals for funding in a form that the bank could not reasonably consider. “As individuals, they may have banked with their bank for many years, and they are surprised when the bank says ‘No’, but it’s because they have not made their business case adequately.”

Brattesani said he had undertaken several presentations recently on: How to make your bank say ‘Yes’. “And frankly, it is all about the obvious things such as giving the bank five-year projections if you want to borrow over five years.”

Hinder: “Businessmen also have to accept that some proposals should never get funding anyway.”

Ross: “There is still a customer base out there that thinks the banks lend money just for the sake of it. They are then surprised when the banks ask what risks they are prepared to take on.”

Barker and Truswell reiterated the need for seed funding, suggesting the Government should side-step the banks and directly provide funds for young businesses, through an independent body operated somewhat like the student loans system.

How do you value the intangible?

Barker accepted that borrowers had to be willing to put up more security but wondered if banks could be more flexible over the type of security, for example by considering IP assets. “We are in a knowledge economy now and many businesses have their assets tied up in their IP rather than physical assets. It gets valued when seeking to acquire businesses.”

Brattesani: “Such assets are very difficult for traditional banks to lend against, particularly with businesses still in a pre-revenue stage.”

Goddard said the difficulty was often in establishing who actually owned the IP.  “It is an asset, but where does that asset sit? Is it truly within the business, or is it with individuals who may leave the business?”

Wood-Smith agreed that IP and branding rights was a hot topic of debate, with many companies trying to get such asset values onto their balance sheets. But, he suggested another viewpoint at the other end of the lending spectrum. “In an insolvency, how often do you get any value for the IP rights. You don’t.”

Working capital issues

Accepting that banks are lending for growth, Murray queried if there were lending issues for cashflow and working capital.

Goddard said his company might step in to provide funding solutions where banks require more security. “We have no shortage of money to lend. As an independent invoice financier, we look at the value of the asset, how much is needed to run the business, and how much we can provide to help it. It’s not like a fixed five-year loan; we stay in daily touch with our asset. Yes, the proposition has to be right, we will want proper forecasts, and will look to continue

to meet the needs of our clients for as long as they need us. We can be more flexible, creative and commercial about the value of funds going out to our clients.”

Brattesani pointed out that HSBC also offers invoice financing facilities. “It is our biggest growth area by a long way.”   Most businesses are now managing their cashflows well, he added.

Ross said some businesses liked invoice finance because it was self-adjusting to the activity levels of their business, and an easy way to get regular funding.

Hinder mentioned the US Silicon Valley Bank which is aiming to offer UK entrepreneurs a new approach through equity funding, using a warrant-based scheme. Murray said the approach appeared similar to the equity investment of the UK Business Growth Fund, supported by five major UK banks.

Murray asked Wilkins Kennedy accountant Matt Hall if businesses were actively adjusting their structures?

Hall: “Yes, we’ve been flat out. Any change in circumstances, but particularly those caused by the recession, will require people to change their structures.”

Business cashflow had been eased by unrealistically low interest rates, he noted. Interest used to be a major tax-deductible cost for businesses, so now businesses are looking at employee share schemes in order to get tax deductions.

We struggle to find the right people . . . then, they won’t move

Goddard: “We are recruiting but like others it is difficult finding the right people, finding skills and enthusiasm.”

Ross: “It is more difficult now to get people to move. We have high transport costs, difficulty selling or buying a house, and so the flexibility and willingness of potential recruits to move has reduced.”

Truswell said the mobility issue was interesting. His company ran a recruitment drive. A Canadian, a Russian, and lots of other nationalities applied, but very few British. “So people will move, but it is very hard to find the right people.”

Ross felt people in a secure job didn’t want to risk moving in the current economic climate. “People are sitting on their own careers, like businesses are sitting on their cash at present.”

Truswell agreed, but noted that 2008 recessionary attitudes were the same: “Then, if you were in a job that looked safe, you sat tight, didn’t look for a rise and didn’t cause any ripples in the ocean. That mood has remained, but I think people should now be thinking of moving on.”

Wood-Smith: From the lawyers’ perspective it is very, very difficult recruiting at the moment. All the firms have made redundancies, and anyone who is any good has been retained.  Those people are now keeping their head down, and won’t move.

Ross agreed saying there had been a recent surprising lack of applications for two roles within Wilkins Kennedy.

. . . and then we fear their employment!

Finding the right person for a job was difficult, but so is removing the wrong person, said Hinder.  He suggested UK plc needed employment laws more on the US ‘hire and fire’ lines that enable employers to remove poor performing employees relatively easily.

“Retaining good people is a problem, but so is getting rid of people when saving costs or because they are not working well.  I suspect some companies don’t recruit because they can’t get rid of employees easily once they are on board.”

Even lawyer Wood-Smith admitted that employment law had engendered far too much dispute and legislation, not necessarily assisted by the many “quasi-legal entities” active in the field. “As lawyers it is a nightmare. To deal with non-performers properly is almost impossible, particularly if they have any discrimination card to play.”

Ross: “Businesses often find it easier not to manage non-performance, and just put up with it.”

Truswell: “I favour the American system with an English compromise, so if employment is less than a year, you can state performance reasons, one week’s notice, no tribunals, employee gone. I would be far more inclined to hire earlier against that model.  At present we are only likely to hire when we as owner-managers feel really squeezed. You shouldn’t need to wait till then, but the reason is the fear of removal, and the potential costs to the business.”

Brattesani revealed that HSBC operates without a probationary period for new employees.

Truswell suggested that employment law was the biggest problem for OMBs, not of their own making.

Barker: “When you take people on you have to be quite creative. You tend to offer them employment on a contract basis to overcome the fear that six months down the line, they may have not worked out. But that narrows down the choice to people who are prepared to join on a contract basis, which accentuates the problem with finding the right people.”

Employment decisions had an extra dynamic for OMBs, said Wilson. “Many businesses are like a family and owners can feel personally responsible if they’ve employed someone for some time and things go wrong with the business contribution of that person.”

As the public sector shrinks, is the private sector picking up that talent?

The reaction around the table was muted, and probably told its own story about the perceived different working cultures of the private and public sectors.

Bailey deals with public sector personnel in his planning application work. “There are good workers there, but they tend to get quickly taken into the private sector. So, you find that year-on-year the same planning officers are there. They are not going anywhere, and who can blame them with their final salary pension to look forward to.”

Ross: “So, the private sector may not resolve the employment gap created by the public sector cutbacks.”

That’s scary ….can you write a letter?

Several Roundtable members felt there was a very real need to upskill the UK plc workforce at the very basic levels – the three R’s.

Barker: “We expected people coming along with GCSEs in Maths and English to be able to tackle basic writing and arithmetic for sales support work, but they couldn’t. It’s incredibly frustrating.”

Wood-Smith had experienced similar with graduates. “We see graduates who have been through law college, and you ask them to write a letter in plain English and they can’t do it. It’s quite scary. It’s the Facebook and texting era. Genuinely, just being able to communicate face to face or by writing a letter is a skill that we are losing, and it’s frightening really.”

Remember, you are a business!

Wilson: “I am finding a lot of FDs are struggling to get back into the market, and are taking part-time work, while seeking permanent roles.” He wondered if some senior management professionals were actually investing in themselves enough, by updating or training in new skills.

Hinder: “People who have been working for someone else and are then forced to go out and work for yourself, are beginning to realise that: They are a business. They realise that they need to establish their core skillsets, their brand, market themselves and form alliances. They are the ones that succeed.”

No one at the Roundtable was taking on apprentices, but several had graduate trainees.

Truswell: “Although we work in high-tech, we have considered apprentices for certain roles. Why not take on a very low cost person, and if they don’t work out then the risk is lower for us.”

Goddard: “That’s been our view too. Traditionally, recruitment has been direct from the banking sector, but why not bring in a graduate trainee and work them up through your business, starting from a lower cost-base? You will pay a fully qualified sales person two to three times the salary of a graduate and if it doesn’t work out, you have to pay them 6-9 months. But, you can afford to take the risk on several graduates, and hopefully some will work out.”

Brattessani pointed out that higher university fees would mean less graduates coming through.

Barker said she favoured vocational training schemes, but the Government was not doing enough to promote them, particularly in engineering. Tax and NI breaks, and reduced business costs for running training courses, would help encourage business take-up.

Retaining top performers

Brattesani and Holt both agreed that retention was usually cash-linked but tended to be through flexible employee benefit packages, targeted bonus or shares scheme rather than a fixed pay-rise.

Hall had seen several OMBs successfully use equity-based schemes, often geared to an exit plan for the company. “It’s a way of giving an upside value to the right people.” Also OMBs often used incentives based on scaled-down versions of big company schemes.  “There are providers around now who can gear more affordable flexible employee benefit packages for the small business.”

Truswell: “I think share option schemes can be a bit fanciful for a small business in Berkshire.”

Brattesani: “A simple performance related bonus is often the best. It is totally transparent. You generate the business, you get the bonus.”

Murray queried whether the public mindset about high pay now needed to be taken into account.

Hall noted that the UK mindset was different to the US where high pay awards were acclaimed as rewards for merit, whereas the UK mentality was to ask: What’s he done to deserve that?  “That attitude is a shame, because it will hold businesses and the economy back.”

What are the aspirations of emerging markets?

With the UK looking for an export-led recovery, the need to see beyond Europe was evident, said Murray. China was the name on everyone’s lips.

Brattesani mentioned HSBC’s work with the British Chambers of Commerce ‘Link to China’ initiative. “I have worked in Hong Kong and Shanghai and seen an amazing world which we all ought to be part of. China will be net-buyers soon, so we can benefit, yet we still export more to Ireland than China, which is the wrong model for the UK. One problem is the perception that the market is too tough to enter, but actually the challenges are now rapidly decreasing. Companies can now trade in RMB, for example,”

Goddard agreed, although no business should underestimate the time and resources needed to gain entry to that market.  “Currently, the perception is the rewards are not quite there, although I think they will be. The cost-efficient strength of the Chinese manufacturing market is becoming diminished because the workers now want to become middle-class, which will give us an opportunity.”

Brattessani: “For China you can dip your toe in Hong Kong without all the problems of setting up on the mainland.”

Wilson revealed the Internet was enabling OMBs to grow exports. A client company, exporting IT equipment to Africa off the back of an in-country website sales strategy, was winning new business through providing a better service at a lower price than its African- based competitors. Its business had increased by 25% per year over recent years. “If you know the markets, you can achieve low-cost set-up successfully.”

Ross of Wilkins Kennedy, also involved with Link to China and UKTI initiatives, said: “Cost of entry comes up time and again, but people have got to be realistic. Where is the European market going? The only way businesses will go forward is by looking beyond their current boundaries. We have some scaryingly interesting statistics of how big the middle-classes of India and China will be in5 to ten years, and these cannot be ignored. There is an opportunity and there are resources available through UKTI.”

Brattesani mentioned reports of Chinese companies seeking to invest in UK companies “because they want our technology.”

Ross: “Many Chinese aspire to buy quality British products, and we have lots of small companies making quality products here as well as well-known large ones.”

Holt: “Foreign funds are seeking to buy property as an investment in London and the  Thames Valley now, but we haven’t seen much appetite yet to set up bases here. The worrying factor is that the 1980s Thames Valley property boom was fuelled by US companies who were not confident to set up in Asia and China. Now they are more confident, and property costs are a lot cheaper over there.”

Hall believed that big companies would still focus on London and the Thames Valley, seeing it as a world business hub for the ‘movers and shakers.’

Wood-Smith felt there would be increasing UK link-ups with the Chinese. “Britain has got a very good reputation for technology, particularly engineering.  We have got a fantastic knowledge base that is under-exploited, so partnering with people with wealth is going to happen. Property I think is a real issue but technology has a huge potential.”

Operating in the ‘cloud’ Barker accepted her market was global by nature, but even so “…we would need to change our technology to go to China. I would feel very nervous about partnering with a Chinese company. I would want someone there who knew that market very well, and I would be worried about the costs of protecting our business.”

Goddard feared a problem with technology link-ups. “They may try to copycat everything.”

Truswell noted that the CEO of Dow Chemicals had said that the company had more patents produced by Chinese graduates in China than the US. “So, exporting technology to China … I would be very nervous about putting our technology into these markets.”

A lot of property, but not enough quality

Property agent Stephen Holt reported a difficult market with hard tenancy negotiations continuing, resulting in a lot of lease regearing. Where lower rentals or better terms could not be achieved, many companies were seeking alternative locations and reaping significant rewards.

“The problem is a lot of the property out there is probably unlettable, even in a good market. There’s not much good quality space because not much has been built in the last four years.”

Brattesani reported four clients ready to buy property, but unable to find the type of property they wanted.

Holt agreed with Murray that the time was ripe to start speculative building. “We have clients who are looking to do that, but it is very difficult to get funding. But, where people are able to fund themselves, or don’t require traditional funding, they are going ahead and achieving pre-lets and even pre-sales.”

Goddard asked what was going to happen to the poor quality property that couldn’t get tenants.

Holt: “Good question! Some are being converted into residential or hotels, but…

Goddard: “Presumably, at some stage the landlords are going to have to make some tough decisions.”

Bailey reported that homebuilding was showing resurgence. “Over the last three years there has been a lack of demand for flats, and plans have been redesigned for housing. Over the last few months, the flats market has started to come back, thanks to first-time buyers, downsizers, and investors.

“London is at the head of the property market and Thames Valley centres such as Reading, Guilford and Oxford are benefiting from the ripple effect as the London market improves.”

New infrastructure?  Why not use more technology?

Reading’s new station would undoubtedly assist the property market, Holt and Bailey agreed. So would a third Heathrow runway, added Brattesani and Hall.  Ross: “There’s one problem, with your nearest airport at 98% capacity and no room for growth.”

Motorways were still “a nightmare” said Truswell. “When I was repping, many years ago, you could do several meetings in a day without stress. Now you can’t.”

“Do we need to use more technology?” suggested Murray. The broad Roundtable answer was ‘Yes, but it’s not always the best option for business.’

Truswell: “We do need technology to gain 24/7 access to information and easy communication, but I don’t think some technology, video-conferencing for example, has stopped face to face meetings.”

Brattesani: “We have internal meetings using video-conferencing but not external. People buy from people and you need to have that social contact.”

Truswell: “It’s all about context. At this Roundtable, for example, you can even hear people breathe, which helps you to know their true feelings. We do our technical selling by video-conferencing, but our closing of a sale is face-to-face.”

Ross asked: “Will technology remove the need for all our offices, remove the need for people to go to a base every day?”

Holt: “A lot of hot-desking is already happening along with ‘plug-and-play-and-walk-away’ offices.  Most companies have gone as far as they can though.”

Brattesani: “We like to work as a team with a family feel, and our offices help that happen.”

Holt confirmed that OMBs were still asking for more office space.

Goddard works both at home and office. “When technology is used properly it can produce a very efficient use of time and resources, but you need to get the work-life balance right.”

Truswell felt hot-desking was the best option, because working from home allowed a ‘pyjama-party’ workstyle, which was not efficient.

Holt agreed hot-desking was efficient, but believed people should be encouraged to break their home life from their business life to avoid ‘burn-out’.

Technology had definitely changed the working week however, with potential 24/7 global availability. “What’s a weekend?” queried Wood-Smith.

 

This Roundtable was held in February 2012 and sponsored by Wilkins Kennedy