The M&A Guide is aimed at entrepreneurs and owners of growth companies, summarising the state of play of the dealmaking landscape and the various elements of the ecosystem over the past year. The aim is to help business owners understand whether a merger, acquisition, sale, or going public is right for their business, and the types of advisers and expertise they may require along the way.
The drive for specialisation in debt finance
Until a few years ago, the provision of debt to companies was the preserve of banks. Colossal organisations whose levels of complexity and layers of management were unfathomable to outsiders and sometimes even employees.
Through ambition and acquisition, these organisations continued their relentless march for scale and expansion in lockstep with the increasingly indebted governments tasked with their regulation. Then the financial crisis happened or, in many people’s eyes at least, was caused by these enormously powerful firms and scale and size went from being a significant advantage to a significant disadvantage almost overnight.
In part as a result of the subsequent economic turmoil, in part as a result of a tighter regulatory regime for banks, and in part as a result of technological advances and sheer entrepreneurialism, the provision of finance to companies has since undergone a revolution with the rise of a myriad of alternative providers of finance. This disintermediation of the business of funding companies and individuals continues apace and the UK is widely seen as being at the forefront of this change.
The innovation charity, Nesta, estimates that the alternative finance market in the UK grew to £3.2 billion in 2015 and yet only 3.3% of new loans to SMEs were provided by peer to peer lenders in 2014. Whilst this share of the market will have since grown, traditional banks, both big and small, remain the primary providers of finance to small companies and that position is unlikely to change materially anytime soon, particularly in the South East where recent research by Avention showed businesses are more reluctant to use alternative finance providers.
Nevertheless, banks should not ignore this threat. Because they don’t have to support legacy infrastructure, alternative finance providers have a far lower operating cost model. They also have more modern IT systems, enjoy a favourable regulatory environment, and will most likely continue to enjoy significant growth and gain some market share. These factors, combined with what has been an extended period of low interest rates which pressurises deposit taking institutions, should act as an early wake up call for the SME focused divisions at the traditional banks.
So, how can the banks react to this threat? One way is simply to ignore it which the largest banks may be forgiven for doing given their (still) overwhelming market share. However, medium sized banks, often referred to as the challenger banks, do not have such scale advantages and so the requirement to innovate from within is that much greater.
So how should they respond? One answer is specialisation. By identifying segments of the business lending market which are underserved, or even just unserved, by larger institutions, challenger banks are able to gain market share and establish a reputation for themselves within a defined niche. This leads to in-depth knowledge and expertise in that particular market segment which in turn leads to further deal flow.
This is a component part of a wider strategy which we at Clydesdale and Yorkshire Bank are pursuing and was launched in early 2015, a year before our IPO in February of this year. Market analysis showed that there was a real need for a bank focused on helping to fund SMEs and the lower mid-market around the UK. It would have been easy to have some form of generic SME banking team, but instead senior management took time to engage with the market and identify a series of niche sectors which are, in their own small way, helping to drive the UK economy.
Specialist teams are now established across the country with a remit to have their expertise acknowledged in their national markets. These teams are as varied as the market demands; automotive tooling, near-shore marine finance, renewable energy, insurance broking, hotel development finance, healthcare development finance and emerging technology to name a few. Other specialisms were established focusing more on the debt product requirement rather than the industry sector, so a venture debt team (called “Growth Finance”) which had been lending to intellectual property rich companies since 2011 was further invested in and a dedicated national SME cash flow team was set up to help profitable SMEs by lending them money based on their cash flow and not personal guarantees from shareholders.
Some of these sectors may not be large enough to warrant the attention of the largest lenders, but being able to combine real sector knowledge and transactional expertise with national coverage from Aberdeen to London is making a real difference to the SMEs in those markets often desperate for finance to help fund the next stage of their growth journey.
David Hayers is the head of growth finance at Clydesdale & Yorkshire Banks.