Insight

Rules to follow when increasing debt

Published on June 20, 2015

This article appeared in the Real Business magazine

Arcadia’s owner paid himself a dividend through debt. Should you borrow more?

When Philip Green paid himself a £1.2bn dividend last year, he wasn’t creaming off profit. The cash came from a seven-and-a-half-year loan from HBoS. Because Arcadia is making £300m profit a year and Green owns 92 per cent, the bank thought nothing of providing Green with some upfront cash. But can small businesses be similarly creative with bank debt?

Private equity houses have been “doing a Philip Green” for years. They use bank debt to pay themselves huge dividends soon after buying companies. Last year alone they siphoned off £12bn using this technique. Michael Shulman of Jade Securities, the mergers and acquisition brokers, says smaller enterprises are now copying this tactic. “Low interest rates mean it can make sense for companies to increase their borrowings. We are finding that these funds, in addition being used for dividends, are also topping up pension contributions. Other companies are looking to purchase freehold properties for their own occupation.”

But what about entrepreneurs themselves? Don’t expect banks to let you do a Philip Green. You need a lot of noughts after your name to have that clout. But there are many other attractive uses for the banks’ cash and the trend among bigger companies towards leveraging the company’s balance sheet is easier to copy if you can make the business case.

Mike Burton runs Albany Washroom Services in Essex, a fourth-generation family company of which he is majority shareholder. With a credible expansion plan and compelling reasons for bankers to support him, Burton believes his best strategy is to borrow money to expand. “Turnover is expected to grow very quickly with profits to follow, but I’ll be investing in an increased sales force and equipment for my new customers, so I need a bank which has innovative ways of financing this.” And Burton is willing to put his own money where his mouth is to get the deal – investing his personal capital alongside the bank to show his level of commitment.

Burton seems to epitomise the entrepreneur willing to take on more debt to pursue a dream that he’s confident of achieving. His company will increase its market share, he’ll retain his equity control, and the bank will recoup its money. All this in a solid industry that has been around for years.

Shulman says tactics like Burton’s are becoming increasingly common as banks search for more imaginative ways of offering finance. “Contrary to the traditional image of the imposing and unapproachable bank manager, today’s bankers really do want you to call them,” he says.

How much debt you should saddle yourself with is a tricky question. There are no metrics or golden rules. My advice? Borrow as much as the bank will lend you, but not so much as you can’t sleep at night. Wing Yip, the entrepreneur who has built a £70m-sales Chinese supermarket chain, advises you to secure as much as you can, but never draw down more than 50 per cent.

If you fancy increasing your debt, here are a few tried and tested techniques for getting your hands on the cash

Rule one: don’t limit your enquiries to your existing bankers. It’s a competitive marketplace out there, and banks are hungry for new customers.

Rule two: do limit yourself to banks whose managers will give you a direct dial phone number for ongoing contact. Ten minutes being told by a recorded message from a call centre in India that “your call is important to us” is not the best way to foster a working relationship.

Rule three: have a credible business plan. My firm prepares loads every year, and bankers give a warmer welcome to businesses that demonstrate a well thought-out future – and financial projections that portray the bank getting its money back!

Other suggestions? Show the bank you’re contributing alongside them. Maybe you’re taking a low salary to help the company’s cashflow, or perhaps, like Mike Burton of Albany Washrooms, you are willing to invest personal capital as a show of commitment.

A bright bank manager will have other suggestions for improving your working capital availability other than debt. But remember that they only earn money when they lend to you. So pick up the phone and put the banks to the test.