Two years ago the world faced a massive financial black hole. Sub-prime mortgages and other fancy products had been packaged up into derivatives worth billions of dollars, and institutions had sold these packages to each other without understanding their true worth. Every company was involved and banks such as RBS and insurance companies such as AIG were within hours of going into liquidation.
This came about because the American government allowed Lehmans to fold. With Lehmans out of the chain these derivatives flew round in what was a terminal game of ‘pass the parcel’, when institutions did not understand what they had bought and the impact on their balance sheets. The 1930s were about to happen again but fortunately the world had learnt (by the adoption of Keynes’ Economic policies) that they must: support the banks; open trade borders; instigate a programme of public spending on capital projects; print additional money to increase liquidity.
This has stabilised the global economy – but we now have to pay for it. The UK’s budget announced this Tuesday is our attempt to eliminate the huge debts we have run up over the last years to put our economy on a strong footing going forward.
At first glance, the task facing the UK economy is enormous. Allowing for the governments assumptions of annualised growth rates of approximately 2.5% in GDP over the coming five years and with a 25% reduction in public spending (made worse by ring fencing the NHS which is 20% of all overall spending) this would appear to be a very big ask. Imagine any business in trouble being asked to increase its sales and take 25% out of its cost base!
Taking for granted that cost reductions can occur the real question is ‘how is the economy stimulated?’ If the assumed 2.5% annual growth rates do not happen that would take £125bn out of the government’s assumptions and would mean a further reduction of 10% on annualised current public spending. There needs to be total focus to ensure UK companies perform well, not just domestically but internationally, and I feel as a result of the last budget that the government has taken its growth assumptions lightly and not provided the support businesses have needed to perform.
In the area where I live there are 20,000 businesses and 85% of them employ fewer than 3 people. They are resilient and forward thinking, but for the most part they are suffering from a total lack of bank support – whether it is short term funding to re-position a business or to finance working capital as sales increase. The government has missed a trick and there should have been policies committing the banks to lend to companies to enable them to finance growth. After all, the government is the major shareholder on two of the largest banks in the UK.
I can demonstrate a typical bank’s approach using the example of a company called Drivelink, for whom I recently considered Angel investment and operational involvement. Drivelink was an automotive business turning over £5m and employing 70 people. It had lost a major customer but had reduced costs to compensate, but its debts were factored, which that gave a short term pressure on cash flow so I was asked to invest and get involved. I was at the point of investing £700k but we required the bank to amortise some of its debt exposure (£150k) and the management were prepared to put further parental guarantees in to support additional bank exposure. This would have resulted in a business with 10% gearing, profitable and able to expand. Unfortunately, the bank said no and the business closed, resulting in a loss of 70 low skilled jobs which are now a welfare drain on the area.
The only solution companies in this situation have is to turn to investors like myself. Banks are unwilling to help, and from a private equity point of view these deals are just too small. I am open and ready to take the right opportunity. However, the government needs to rethink its strategy on bank support for businesses if we are to create an enterprise-led recovery, let alone hit the growth targets assumed in the last budget. It also needs to ensure there are capable people making the right commercial judgements at the banks.
Opinion | business, government, advice