Debt is like medicine. Too much and the patient gets sicker. Not enough and the patient does not get stronger. Just right and the patient becomes investment grade…
How do you run the debt book of your business? Surprisingly, more often than not, the company leadership at SME’s (small to medium sized enterprises) does not have a specific plan. They look for the cheapest price, they look at current needs, and if it works, great. Contrast that with the SME’s big brother, LME’s (I just made that one up, but it stands for large to medium sized enterprises) and the way their treasury staff approaches funding is night and day. They actively look at the optimal ways for financing growth.
LMEs optimize for three variables:
Tenor – would you take out a mortgage where you had to refinance every 12 months? Of course not, yet SMEs do this all the time. Whether explicitly (i.e. the borrower has to re-apply every 12 months and can potentially be turned down!) or implicitly (i.e. the loan is evergreen, but can be called at anytime and for whatever reason and/or the rate is reset based on the current Prime Rate (common for SMEs) or LIBOR (less common). In either case there is no locking in for 5, 7 or 10 years or more.
Price – price is important, but only directionally*. This means institutional versus personal funding costs. The difference is stark and is the difference between professionals who run a low risk, highly profitable business and newbies trying untested methods in a business with little to no operational history, with management trying to develop clients and still pay the bills. In other words, one looks like a mortgage payment, the other like a credit card payment. Financing growth means funding in the institutional market.
Terms – this is the one that trips up almost all SMEs. Terms do matter, more than the amount and more than the price in most cases. Yet terms are almost an afterthought for those trying to get a business off the ground, but the seasoned treasury staff is able to translate the needs of the company’s long-term strategy into terms that allow the company to grow. The terms are the first hurdle to be agreed for large companies and the last hurdle to be agreed for small ones. That statistic, in and of itself, should focus the mind at the leadership at the SME.
So if you want your SME to grow into an LME, then focus on the big three of funding: tenor, price and terms. Make sure they marry-up to your company’s long-term business plan. Keep focusing on these three forever, and you’re leadership team will be positioned well for financing growth.
*if you’re a current client, don’t worry, we’ll fight for every last basis point for you – this is for illustrative purposes only 🙂