Why managers need to be more city-savvy
Engineering management needs to address the convoluted world of high finance in order to survive the credit crunch.
There are something like 550 banks in London's financial district. But what do they do, and how are they helping the engineering and technology sector? The City of London and Canary Wharf is packed to the rafters with institutions who we suppose exist to lend us money, so where is the support of the banks and other big City institutions when more and more companies need it?
Once there were merchant banks and clearing banks and the Square Mile was best known for the Bank of England, the London Stock Exchange and Lloyds of London. A famous banker once tried to explain the difference between merchant banks and clearing banks. "Merchant bankers," said Jocelyn Hambro, former chairman of Hambro's Bank, "aren't supposed to be conventional bankers. Merchant bankers are supposed to be risk takers, as opposed to joint stock (clearing) bankers who never take a risk; but manage to lose money all the same."
The 550 international banks and 170 global securities housed in the square mile and at Canary Wharf include giant investment banks like Bank of America, Citigroup and Goldman Sachs; overseas banks representing nearly every country in the world; banks specialising in Eurobonds, foreign exchange, energy futures, global insurance; and long-established merchant banks like Rothschild, Schroders and Lazards.
The Bank of England, the government's banker and 'the bankers' bank', the London Stock Exchange and Lloyds of London, the world's largest insurance market, and Baltic Exchange, the global market for ships' brokers, place London on a par with New York as the leading centre of global finance.
The London foreign exchange market is the largest in the world, averaging a daily turnover more than New York and Tokyo combined. The city is also the world's largest fund management centre, managing almost half of Europe's institutional equity capital.
Where's the interest?
What makes the City important to British companies is its huge range of financial services. When companies need foreign exchange, project finance, asset finance, trade finance or syndicated loans where huge funding schemes are involved, the City normally finds solutions.
London is also the biggest market in the world for derivatives traded over the counter with 30 per cent of global turnover. And just over half of the global foreign equity market and 70 per cent of Eurobonds are traded in London.
The City's supremacy, however, shouldn't detract from the range and strengths of financial services built up in key UK centres. Manchester, Leeds, Edinburgh and Birmingham, for example, are important financial centres and most have the professional skills that the City offers, if not the standing of the 'square mile', says Paul Storer, director of Corporate Finance at Cambridge-based Chartered Accountants Price Bailey.
Storer is a former joint chairman of the UK200 Group's Corporate Finance Panel, the Group that represents some 150 leading firms of independent regional accountants, lawyers and corporate finance specialists. Storer attracts small- and medium-sized businesses looking for advice on floating on the stock market, private equity, venture capital, merger and acquisition as well as strategic advice. The point is, he and his colleagues have access to City contacts and the know-how that companies need at some stage of their development.
For many ambitious growth companies a time may come when they want to go public and seek a listing on the London Stock Exchange, or one of the junior markets AIM or PLUS, to raise funds for development now and in the future, although in the present climate this is clearly not the best time.
In today's 'credit crunch' environment, how difficult is it to raise finance? If your track record and future plans encourage investment, the market will probably find ways of accessing the necessary funds unless you are in danger of breaching existing loans or already have a high level of debt. Venture capital companies, are still supporting start-ups and fledgling businesses.
Planning for growth
Before you approach them, however, you need a business plan and a business model, showing potential for growth, driven by experienced and capable management. In return for a high (possibly as high as 40 per cent) equity stake, venture capital funds will look for a profitable exit strategy after four or five years.
Finding investors is not easy, as you've probably seen on TV's 'Dragon's Den'. Not so long ago private equity funds were seen as the Barbarians at the gates. Today, private equity funds own huge chunks of industry. They are said to be risk averse, but do take risks and not all their investments pay dividends - or survive. The point is, with record sums to invest, can start-ups and smaller ventures count on some of their largesse?
Assuming you've got a great idea for a new business, but need serious funding, can you count on your bank's support? Or is venture capital a more likely route? Or private equity funding? Or business angels? How do you find them and, having found them, make the best choice?
There is a lot of private equity capital about for small businesses, says one corporate finance adviser. How can it be accessed? "If you want funds to expand your skills base, achieve faster growth or launch new products, money can be found.
"Your first point of contact should be your accountant or lawyer, especially if they have corporate finance expertise. They can help you prepare a professional approach to your bank. They are also likely to have a network of contacts looking for investment opportunities."
To attract outside funding, a company, whatever its size, must show evidence of a strong management team, effective financial controls and a business plan with forward projections showing how investment will speed up growth and profits. If you've already got a proven model, you need a sound balance sheet.
If you are ambitious for your company to go for a full listing on the London Stock Exchange, following strong growth or consolidation in your sector, which could encourage further such moves, a three-year track record is necessary and the appointment of a NOMAD. This is a nominated adviser (can be a broker or a bank), which has the purpose of helping to bring the company to market, to deal with corporate governance issues and to remain responsible for its behaviour.
Dealing with any financial institution, or professional advisers locally, will quickly bring you up against the working of corporate governance (i.e. Cadbury, Greenbury, Turnbull and Higgs reports) now enshrined in the combined Code on Corporate Governance published by the Financial Reporting Council in June 2006. Listed companies are not legally obliged to comply with the Code's provisions, but must show how they are applying the principles of the Code and explain why they haven't applied all of its provisions.
For large companies planning to go public an IPO (Initial Public Offering) is necessary, starting with the appointment of a bank or joint banks with experience of floating similar companies. This is where one of the more interesting aspects of the process comes into play.
Arranging a 'beauty parade' of selected eligible banks usually takes place, just as would be the case when appointing a new advertising agency and inviting several agencies to present their credentials and creative ideas.
Developing a subsequent close relationship with financial advisers is crucial and helps build market confidence and interest among potential investors.
Explaining the strategy
From the moment your company is listed, be prepared. Your life could change dramatically. "If you have a senior role in a listed company, it's highly likely you will have to spend a large proportion of your time dealing with investors, explaining strategy, communicating results and justifying why things may not have gone according to plan," says John Spayne, a former managing director of Lehman Brothers, investment bankers, and previously with Flemings and BZW before starting his own investment banking business in 2004. Spayne Lindsay specialises in mergers and acquisitions, management buy-outs and buy-ins, fundraising and refinancing
A CEO of a listed company can spend nearly half his or her time with investors rather than running the business. According to Spayne: "This can be very frustrating and come as quite a shock for managers used to concentrating on operational issues.
"Worse still, when a manager has spent months and months getting to know a particular investor explaining company and strategy, he or she may come to the office one day and hear that the investor has sold his/her shares and has no further interest in the company. So the 'courting' has to start all over again with a new investor."
A positive aspect of the City is that the plurality of investors, often numbering thousands, gives a strong element of autonomy that's not enjoyed in private equity, where management teams, unless they are very strong and experienced, are very much operating at the behest of the private equity owner.
Sooner or later you are likely to be concerned that your company's share price isn't performing as well as it should. How far you can influence the share price of your company? "There is a limit," says Spayne. "The share price will often fall because of reasons wholly unrelated to the management team's performance." For example a statement from the Federal Reserve in the US or a sector wide issue could have a negative impact on a share, even if the company is actually performing well. This can be a shock if a manager's compensation package is linked to share price progression.
"Fundamentally, the city thrives on change. For many brokers and traders it doesn't really matter if the news is good or bad so long as there is change. No-one enjoys the vicissitudes of the market more than the hedge funds who increasingly are playing the role of activist shareholders, building up large positions in companies and trying to influence strategy from the sidelines: often a 'break up' strategy."
Companies with a market capitalisation of £35m to £40m or less aiming for a public listing often find the Alternative Investment Market (AIM) more attractive and less demanding than a full listing.
The AIM market has been in existence for more than a decade now. Almost 3,000 companies have joined since the launch and a staggering £58bn has been raised. Average failure rate in the past four years has been less than 3 per cent per year. The downside is that junior markets attract very little publicity and not a lot of interest in the shares or share movement.
How necessary is it to go to the City if your company needs professional advice or fundraising or future development? "The City is the powerbase of capital," says Storer, the corporate finance specialist with 20 years City experience before settling in Cambridge. But he maintains all the professional skills associated with the City can be found in Manchester, Birmingham, Edinburgh, Glasgow or Cambridge: for example accountancy and legal services, patent agents, merger brokers, banking and finance specialists.
Storer makes the point that when he qualified "it was important to work in the City, but many of my staff learned their skills outside London.
"You can now find more stock brokers outside London than in the City."
There may come a time when well-established companies with an historically strong balance sheet need an urgent infusion of funds and mount a 'rights' issue or a call for cash from existing investors or shareholders, often a hugely expensive exercise, as recent cash calls by the Royal Bank of Scotland and HBOS found, but an important measure of market confidence.
RBS's outlay of billions for a Dutch bank plus losses on subprime property led to asking shareholders for £12bn in new shares - one of the biggest share cash raising exercises by a British company.
'Rights' issues have to be underwritten by investment banks in case not enough shareholders can be tempted to buy and take up the entire offer. In this case, two major investment banks agreed to underwrite the new issue - for a fee of £246m, a good example of how City institutions use their collective muscle and experience to earn high fees.
In the case of HBOS's £4bn rights issue, which hoped to gain the backing of 98 per cent of investors, two banks, Dresdner Kleinwort and Morgan Stanley, are expected to pocket up to £90m in payment of the underwriting.
When the 'rights' issue was launched last year the shares were 998p. At the time of writing, they are 282¼p. Barclays too is raising as much as £4.5m to absorb credit-related writedowns.
Neither the banks nor shareholders seem prepared to help the growing number of companies hit by the worsening credit crunch - companies like house builders weighed down by debt, falling order books, poor sales and a slumping share price. Barretts, for instance, is struggling with £1.7bn of debt and has been locked in with its ten bankers to find a solution to its problems. It faces the problem of axing 1,000 jobs. Taylor Wimpey needs to raise £500m and expects to make 900 job cuts.
A rescue package for people's savings at a minor bank to avert a banking disaster was, arguably, more important than saving jobs and house building targets. Why can't the banks, especially the Bank of England, the Treasury and the FSA in their combined wisdom offer help?
Banks and other City institutions can be very unforgiving as well as unhelpful when you most need them. Breaching loan agreements and covenants is a cardinal sin. Profit warnings are bad news. Slashing dividend forecasts can cause real anger. And if a chief executive tries to move up to the chairman's role and combine the two jobs, as we've seen in the case of Marks & Spencer, such 'dangerous' concentration of power will definitely not win friends in the City, besides going against the spirit of the Combined Code in Corporate Governance.