By Reader in Accounting and Finance; Director of Internationalisation, Brunel University London and , Associate Professor in Finance, Kingston University
The banking sector is currently experiencing great strain, which has resulted in several bank bailouts – most recently UBS’ deal to buy its Swiss competitor Credit Suisse following a collapse in confidence in the latter. HSBC’s acquisition of the UK arm of the collapsed Silicon Valley Bank the previous week brought great relief for its depositors, many of which were small tech start-ups.
SVB’s UK clients were lucky that the government facilitated the rescue deal so quickly – it was announced the Monday after SVB collapsed in the US – but they still endured several days of worry and uncertainty beforehand. And with financial markets now responding to continued concerns about the banking sector, particularly in Europe, it doesn’t look like all banks – or their clients – are out of the woods yet.
At a time like this, many small businesses will be thinking about their finances and how to make them more secure so they don’t face the same fate if there are similar situations in the future. Here are four ways to shore up your small business banking in preparation for uncertain times:
1. Split your accounts
As a small business, you may not have the means to diversify the range of products or services you offer right now, but you can diversify your banking portfolio. This means, rather than tying up your business needs with one bank, keeping some money and loans with a couple of different institutions.
Speaking of which, when opening an account with a new bank, get the full picture of its strengths and weaknesses. This means checking for any significant recent changes in its assets or its sources of finance, which will tell you if its business is concentrated in any one industry.
Similarly, don’t just open an account with the bank that your industry peers use. SVB’s collapse has been partly blamed on its concentration in the tech sector. Although this means a bank can develop specialist expertise and understanding, it can also leave it exposed if it’s main sector experiences a downturn.
2. Be careful when banking beyond borders
The ease of online communications and payments these days means even small businesses can expand overseas. But when operating in a different country you should consider the cultural values of a country because research shows this can affect a bank’s attitude to taking risk.
For example, in some countries, banks are allowed to operate with less easy to access money on hand in case of a problem, but governments are more reluctant to bail out failures, meaning your money will disappear if your bank fails. Before you choose a bank beyond your borders, collect information about its operational behaviour to gauge how much risk it likes to take. You can find this in published financial statements, media articles and by speaking to others in the industry.
3. Consider a range of borrowing options
You might have an excellent business idea but without hard assets, it can be difficult to get a bank loan. There are plenty of other options such as R&D grants from local or national governments.
You could also look for investors, which is called raising equity. It essentially brings more money into your business. This can help lower your leverage ratio, which means you have to give over less of your profits to a lender and can reinvest money in your business instead.
In other words, consider exploring ways to hold less debt, even when you are a growing business. There is no standard debt to equity ratio, it depends on the business. Some people think that less debt indicates that the business is not growing, others believe less debt makes the business stronger because it has more cash on hand for daily operations, rather than relying on credit.
Many small firms, particularly in the tech sector, look to venture capital firms for funding. A shorter-term source of money, they usually buy a stake in a start-up idea and then exit as the company grows and becomes more valuable.
Venture capitalists charge management fees, which are higher for businesses seen as a risky bet. You also typically pay them a share of the profits. And as with any business deal, check credentials such as funding, other business relationships and investments before signing.
4. Set up an emergency fund
Try to maintain one third of your typical monthly expenses as an emergency fund – but even if you can’t manage that, set something aside. And don’t forget to top up the emergency fund if do have to dip in.
Also, think about where to keep your emergency fund. Popular places include high yield savings or money market accounts because they are easily accessible, especially when you need cash in hand. But remember to check the policy for how quickly you can convert any holdings to cash. And keep the relevant paperwork updated and in a safe place that you can access quickly.
Although you have the ultimate responsibility for your own small business finances, the regulator still plays an important role in supporting and protecting the financial system and those within it. The UK Treasury recently published a report on its Future Regulatory Framework Review. This aims to identify any changes the government and regulators believe are needed post-Brexit to ensure the UK remains competitive.
Such rules should protect the sector from problems, such as the current banking sector issues in the US and now Europe, while also ensuring start-ups and small and medium sized businesses still have access to a strong financial services market.
The HSBC deal to rescue SVB’s UK arm was a reassuring short-term arrangement from the UK government, but the long-term objective should be be to ensure the UK’s regulatory framework protects otherwise healthy firms – of all sizes – from failing during a crisis.