Dividend yield, particularly for listed companies, is an important element to generate shareholder returns and – crucially - their support. Even in large and medium-sized private businesses the dividend yield can be an important element in terms of returns to shareholders and may be the key driver for shareholder investment in the first place.
We have all seen the press regarding the cuts to dividends from many of the FTSE 100 constituents due to the COVID-19 pandemic and the resultant economic fall-out. For small private companies, one would expect that the reduction to dividends will be even more severe. This is understandable as companies batten down the hatches and conserve cash to get them through the periods of poor trading.
For small businesses, and particularly family-run or owner-managed businesses, dividend payments are often essential and may make up the majority of the remuneration for owners and managers. However, there is a delicate balance to strike with regards to paying out or saving/reinvesting earnings.
At ArchOver, we see far too often small businesses that have been sucked dry of cash by excessive dividend payments. We are then approached to provide working capital, often with a view to maintaining the excessive dividend payments, meaning that they are now funded by debt rather than earnings. Clearly, few would believe that this is a suitable use of funds!
Many companies go through periods of feast or famine, but maybe companies should seek to smooth the cycle by taking out less cash in the good times in order to maintain a buffer for the bad times. Whilst taking out dividends to pay for little Henry/Henrietta’s school fees could be viewed as an essential for some, replacing the Maserati each year may be something that could be sacrificed for the benefit of the business. Then, when the company is hit by an unexpected crisis such as the COVID-19 pandemic, it will have a buffer of cash to weather the storm.
In April 2020, the Bank of England reported that UK households deposited £16.2bn into savings accounts, more than three times the average over the previous six months. This was most probably because those lucky enough to still receive a monthly income enjoyed significantly reduced costs during lockdown and wished to build a cash buffer for the future. Although currently it will be difficult for most small companies to start increasing their cash reserves, maybe there is a lesson to be learnt from the general public.
In addition to increasing cash reserves by retaining earnings, one further option is to raise debt in order to provide that cash buffer on an ongoing basis. Although obviously there is a cost to maintaining debt, it is worthy of consideration, particularly as it has become obvious that nobody can predict what crisis may be around the next corner.
Holding a manageable level of debt allows businesses to retain a cash buffer to enable them to continue trading when there is an unexpected dip in revenues. ArchOver specialises in lending to businesses that may not fit the criteria for borrowing from traditional bank sources and also may not fit the criteria for Government-backed lending during the current crisis.
To adapt a pithy phrase from Deputy Chief Medical Officer Professor Jonathan Van Tam - and probably the only amusing statement from 2 months of daily COVID-19 Government briefings - ‘Don’t tear the pants out of’ your company by stripping out excessive dividends!