From the outset I want to state that this article is not intended to be bank bashing in any way – we are all in business to make money, the banks included. I don’t believe there is anything wrong with that. When negotiating with a financier it is important for SME owners to embrace this notion. The more a business owner understands about how attractive or unattractive their business is to a bank, they can make much better strategic decisions at the negotiating table.
The old adage “you get what you pay for” is as true in finance as it is when purchasing any other goods or services. If your business is reliant on the products and services provided by a financier, you would want them to be making a fair return on their investment – it just makes business sense.
I learnt this lesson early on in my 7 year stint as a Senior Business Banking Manager for one of the majors. About three months into taking over the portfolio, one of the more high-profile clients asked me, “Do you know why I don’t harass you every week about my interest rate margins, because you know I could?”. My response was short and simple “no”, knowing full well that I was priced about 0.2% above what he could get elsewhere for a significant chunk of secured term debt. “It’s because I want you to want to answer my phone calls”. This discussion stuck with me. This client knew what he wanted from the bank, but more importantly, knew exactly what he was prepared to pay for this service. As a banker I knew I had been put on notice from the outset and you know what? I always took that call over the 7 years I looked after him.
So, as an SME business owner, how attractive are you to a financier? You need to start by looking at the obvious revenue opportunities you provide a bank through your day to day business operations. The obvious opportunities are as follows:
1. Term Debt – Most businesses will have a piece of term commercial debt. Most common examples include loans for business or commercial property purchases etc. Most financiers price term debt off the Bank Bill Swap Rate. There is normally a margin to cover a financiers “cost of funds” as well as a secondary margin or facility fee based on the clients individual risk profile. There are plenty of ways to reduce a financiers capital cost under term debt arrangements. The more you can reduce a financiers cost of funds, the more pressure you can put on the individual risk margin without impacting the overall return to a financier. Get in contact if you want to discuss these further (this could be, and is likely to be, a whole other article).
2. Working Capital Facilities – Many trading businesses require some form of working capital funding to assist with their cash conversion cycle (the amount of time it takes to produce stock, sell it and then convert it into cash). Common facilities include Bank Overdrafts, Invoice Finance (Debtor Finance), Trade Finance / Letters of Credit, Bank Guarantees. These facilities provide a great source of revenue for financiers and are often priced to reflect a lower level of security than tradition term debt facilities. Once again there are strategies that can be implemented to reduce a banks funding cost under these facility structures, thereby allowing a client to place pressure on risk margins without impacting a banks overall return.
3. Asset Finance – Capital Expenditure and upgrades can be a key to managing operation and maintenance costs for many trading businesses. When a business upgrades vehicles, machinery, forklifts etc they are often better off financing the purchase to minimise the cash flow impact. This provides a financier with another source of revenue. Financiers will often have pre-approved leasing limits in place for sound trading businesses.
4. Home Loans and Personal Banking of Directors and Shareholders – with regards to the smaller sized businesses, often the directors personal assets are tied up in the business security structure. If this is the case you need to make sure you are getting a competitive deal on your personal finance facilities. Home loans are a low capital cost product for a bank (everyone wants them but not every lender can do the business side of the equation). It is also very important that shareholders maximise rate reductions on non-deductible debt (often referred to as bad debt) and also negotiate a structure so that the “bad debt” is paid off prior to repaying the tax effective or investment debt. If you haven’t spoken to you accountant or financial planner about tax effective debt repayment strategies you should (right now even before finishing reading the article!).
The above shows that a majority of trading businesses will easily generate 3 or 4 different revenue streams from each SME client for a major bank or financier. These revenue streams are pretty plain to see and can be heavily structured and negotiated with a lender. There are however a number of other sources of revenue for a financier that aren’t as obvious. These are often overlooked by SMEs when negotiating however, I can assure you the financier is well aware of them:
1. Merchant Facilities / Deposit Funds / Transaction Accounts – This all comes under what the major banks refer to as “transaction banking” and can be very lucrative when provided to an SME that has high turnover (in terms of quantity of transactions). When offering merchant facilities (eftpos machines, online payments gateways etc) all providers (banks) are charged the same “interchange rate” by issuing card companies (VISA, Mastercard, AMEX etc). The banks then pass on these costs (and add a margin for themselves) in the form of merchant fees. If your business has a large volume of transactions processed through a merchant facility you need to look closely for the most appropriate deal. Also remember, as your business grows and changes it is important to review these offerings on a regular basis as the mix of cards may change. For example, you may have a merchant offering priced competitively for budget or basic credit cards however your client base may shift towards premium cards over time with your clientele. In this case the aggressively priced budget option is not likely to be suitable as you would be getting charged a high margin on the premium cards.
2. Foreign Exchange Conversion and Hedging – Many SME’s are involved in importing or exporting a product or service. Any time you convert money from one currency to another you are being charged for it. It is quite easy to tell what margin a financial institution is making on a currency conversion if you keep the details of the transaction handy (including the time of the transaction as currency markets are live). You can then compare the rate you were given against the LIBOR interbank rate at the time of conversion. Right now, as I write this article, there is a 3% (0.0308) difference in the AUD / USD rate offered by my bank and the interbank exchange rate. This may not seem like much but it equates to $3,080 for every $100k. This is huge if you are talking to an importer or wholesaler who operates in a highly competitive markets on tight gross margins. As your levels of foreign exchange increase, you can negotiate better margins (just like with lending) however many SME owners are not aware of this. Many SMEs also say to me that they don’t need to worry about foreign exchange because their overseas supplier invoices them in AUD. I can guarantee you there is still a conversion of currency happening there (just at the other end which will impact the AUD price they are offering you). It is amazing to see how much you can save if you ask for a duel invoice (in AUD and USD) and take on the responsibility of the foreign exchange conversion. All businesses that have an exposure to currency need a strategy, not only to make sure the conversion rates are fair and reasonable but more importantly to hedge against potential fluctuations in currency markets. We have seen many businesses brought to their knees due to a lack of a robust hedging policy.
3. Fixed Interest Rates – A large portion of borrowers like the concept of fixed interest rates as they provide certainty of costs for the duration of the fixed term. I think all borrowers with term debt should consider a wide variety of hedging strategies based not only on projected interest rates but also their projected underlying cash flows. What a number of borrowers don’t understand is that when you take out a commercial fixed rate a financial institution normally applies a margin on top of the interbank swap rate, often making additional revenue from the transaction (margins significantly vary across institutions and types of transactions). Whilst there is not normally a huge amount of room for negotiation of this margin on the smaller transactions, being aware that a financier is making money on this makes an SME more attractive to a potential lender if you are keen to hedge.
4. Wealth / Financial Planning / Insurance – Many SME business owners have insurance products with their financier (although this may change as the major banks look to divest their wealth businesses in response to the Royal Commission). Just be aware of the relationship between your insurance and financial planning providers and your financier. If there is a common link this may mean an additional source of revenue is being received by the bank and could work in your favour during a negotiation.
5. Referrals – This one is often overlooked but is very important to a financier. If you are a small professional services business (accountant, financial planner, real estate agent, lawyer, conveyancer, mortgage broker, insurance broker etc) developing a referral relationship with your financier can be very beneficial. Whilst it is difficult for the financier to quantify, when negotiating your SME business facilities it doesn’t hurt to remind them of additional revenue opportunities you have put in front of them!
There are actually many more potential sources of revenue for a financier within SMEs however I will leave it at the above or this article will never come to an end!
The key take-away here is for SMEs to begin thinking about what they are worth to a potential lender prior to entering into a negation. Often the more you know, the better the outcome of that negotiation. Also, if you are looking to push the envelope on terms and pricing it always helps to reinforce the full opportunity that is being presented.
Obviously, every banking proposal is different depending on the applicant and the underlying business. At HT Capital we take the time to understand not only your business, but also your future for both the business and your personal wealth creation. Armed with this information we are renowned for negotiating some of the best finance structures in town.
Don’t be afraid to reach out!
Commercial Finance Consultant – 0458 571 773