22nd Mar 2023
Paul Marriage discusses the events of the past week in the banking sector.
At both Silly-con Valley Bank and the Sam Banking-Fraud chap over at FTX the clue was in the title. Some of you may also recall that I’ve compared the UK to Switzerland on the basis of both being high tech knowledge economies on the edge of the EU – they have mountains and chocolates, we have aircraft carriers and, thus far, sound big banks. As expected, we did manage to find a UK plc with the RIC code SVB, it was a Lloyds underwriter called Spreckley Villiers Burnhope and it ended up as Novae, eventually leaving the market to a US consolidator in 2017. One of the notable things about this bank collapse is how many UK plcs had some banking line exposure to the bank and with HSBC coming as the white knight there is no existential threat. Very broadly the list of companies happy to ‘fess up to SVB exposure is more likely to have found a home in our short books rather than as long holdings in recent years. Playing into our natural cynicism of for all things novel in finance we were always quite amused when a company said they were delighted to have brought Silicon Valley Bank into their lending group – all rather more glamorous than the Midland Bank (1836, Birmingham, Warks) who they now owe their survival too.
In broad terms SVB had an appetite for higher risk, jam tomorrow business that most banks will shun. You do not have to go far to find a small growing business in the UK that struggles to find growth finance; there is clearly a gap in the market for risky finance today and hence we support the government’s swift action here. Companies often get started with credit card debts, friends and family loans and mortgage drawdowns. The sensible overdraft from a credible bank on day one is unheard of. Even when Tellworth started the only people who would bank us were a garish start-up who were a stock market disaster with client service to match (we were happy to be short there, and now bank with a big five). The route to growth finance via tax efficient equity raises is well trodden by nano caps. Getting it right in the eyes of the HMRC is not simple and by the time profit and cash flow is achieved to the level they are bankable to all but the SVBs then the founders’ equity has often been diluted to the extent they have almost become disincentivised despite their entrepreneurial bent. Companies house data suggest that only 38.4% of companies set up in 2016 survived to 2021, while more than 90% of companies survive their first year1. The UK government has not had to bail out SVB, and all customers will welcome the arrival of HSBC, but the various attempts over the years to provide growth finance from 3i (founded in 1945 by the Bank of England as the ICFC), Business Growth Fund (2011 – big 5 UK banks after 3i had grown up) are to the British Business Bank (2104 – Dept for Business), all valiant efforts to solve this issue to some degree. We recently met with Funding Circle, the listed lending platform that targets the same capital shortfall in small business; the business hopes to turn a profit in 2025 and trades at a little more than 10% of the much hyped IPO valuation in 2018 which suggests however strong their current investment case, it’s hard yards making consistently good returns in this part of the finance sector.
For listed investors like us, we are looking for solid balance sheets and profitable companies at the time of investing. For the Tellworth approach in investing the point of peak financial risk should be long past by the time we arrive, we would also hope this is the time when profits are growing at their fastest rate. While it is not a large part of the investment pre-amble seeing how newish companies have got to where they are at IPO it is nonetheless educational. We see very few businesses that came through the EIS route, perhaps because early round valuations make IPO pricing trickier or more likely they have been swept up by other private companies along the way. The newly renewed debt facility with High St banks at a competitive rate that is not fully drawn down and stands at less than 1x EBITDA is probably the gold standard for a new to market company. The past history of ever-changing banks and facilities, easily found in the high numbered pages of a prospectus are clearly a red flag. When a struggling plc announces a stay of execution enabled by a new finance facility the alarm bells are already ringing on the life support monitors – the residual value for equity holders at this stage is probably immaterial. Overall, the longevity and stability of equity finance provided by the UK listed small cap market has proved to be decent for both companies and investors – funnily enough that’s why we exist. On the morning of the 13th March companies were falling over themselves to say they had no exposure to SVB; in many cases it was almost as if they were trying to say ‘you might think we’re flaky, in fact we look a bit flaky, but despite our best efforts nothing to see here’. I have been careful to title this piece a prologue being mindful that the cupboard may only just be starting to free itself of skeletons. The epilogue might be much more educational for us all, we’ll keep you posted.
The views and opinions contained herein are those of Paul Marriage. They do not necessarily represent views expressed or reflected in other Tellworth investment communications or strategies and are subject to change.
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