A good deal has been written recently regarding the attitude to SME lending by the major banks. On the one hand we have SME owners frustrated by their inability to attract bank funding and on the other we have the banks advertising and talking up their preparedness to fund SME’s.
Why do we have this disconnect of views?
It is clear that since late 2008 and the commencement of the GFC, banks have been more wary of lending. The financial crisis – caused largely by risky lending and banking mismanagement – combined with subsequent higher liquidity and capital requirements have made for a far more risk adverse approach.
However, banks are lending and they are increasingly keen to do so. They are lending less than they used to and looking for tighter security, but the idea that they won’t lend to anyone is simply not true, but you must submit a well-reasoned, structured, quality application.
This myth is not only hurting the banks, but it is hurting SME’s. A problem is that we hear so many negative stories of loan applications dragging out for weeks before amounting to nothing and of bank BDM’s being excited by your application only to have it knocked back by credit that many established businesses with sound bankable propositions are not even applying for funding
Other SME’s will get a rejection from one bank and assume they fall into the ‘do not lend’ category, and give up – whereas in a more positive climate, they might keep trying. This is slowing business growth and therefore the growth of Australia’s economy.
Why is everyone saying that ‘banks aren’t lending to SME’s’?
To answer the question we need to understand the lending process and rationale applied by the banks. Decisions are no longer made by your local manager who in days gone by would have known you, your business and the state of the local economy in which you operate. Lending decisions are now centralised and subject to stringent internal rules, guidelines and matrix ratings.
It is possible in this centralised and semi-automated system of credit approval to fail simple because you can’t “tick” a given box. So let’s look at some of the actions you can take to improve your chances of success:
In tough times banks require a near perfect credit history with no defaults, judgements or slow payments showing on your credit history. The reporting agencies make mistakes and many suppliers make mistakes so it pays to request a copy of your credit file from the main agencies such as Veda or Dunn & Bradstreet and check that it is accurate.
Recently our Credit Manager brought a large monthly trading account application to me for approval, the applicant trades nationally and is at the upper end of the SME definition. On the credit file were two very small sums of money showing as outstanding for over two years to a major utility company. Had I been a computer I would have rejected the application but as a reasoning person I could accept that such small sums were inconsequential against the annual revenues of the applicant. A quick conversation with the applicants CFO satisfied me and the application was approved.
For a relatively modest annual fee the reporting agencies will provide you with email notification of any changes to your credit file and provide a fully detailed up to file each year.
Most banks from time to time place a limit on the amount of funds they will advance into a certain business sector or avoid some sectors all together. In late 2010 we had a client with a strong business case and sound backing who wanted to acquire assets in the wine industry. At that time none of the major banks would lend to any “non existing” wine industry clients. Don’t be afraid to question the banks BDM as to their attitude to your sector and if the BDM doesn’t know ask them to find out.
Business Plans, Budgets & History:
Being able to table a well-constructed funding application supported by a current business plan, detailed budgets including P&L, Balance Sheet and Cash Flow will help enormously and if you have maintained accurate records of plans and performance over the past three years even better.
The plans and records don’t just show how your business has performed and how it may perform in the future they speak volumes about you as a thinker and manager.
It’s relatively easy for you to know how you stand from a profit and cash position on a monthly basis and you may question the time and investment required in maintaining such detail but believe me it will pay you dividends time and again to do so.
Provide information about your management team. This will be a key consideration for any lender. You need to show you have a team that can develop the product, market and sell it, and just as importantly, manage the finances. If you have gaps in your team, try and fill them get one in place before you apply.
Interest Rate Cover & Security:
The banks will calculate how many times cover your current net profit will give to the total amount of interest payable and they will want that cover to be 2.5 – 3.5 times as a minimum. For additional security the banks will look at your stock and debtors and advance funds against that security, again they will be conservative and depending on the age and condition of stock may lend 60% of cost and up to 80% of debtors. The bank will also look to take a charge over the various assets of your business.
As a general policy you should, wherever possible, avoid giving personal guarantees or security over your family home and always seek professional advice before executing any loan documentation.
Amortisation & Exit:
An often over looked point which the banks will be very interested in is how quickly can you repay or amortise the loan and how you plan to do it.
The banks don’t want open ended facilities and they want to know you have more than one option to repay, irrespective of anecdotal reputation banks do not enjoy having to collect on defaults.
Hopefully you will be able to demonstrate an ability to amortise the loan over a reasonable period whilst still leaving sufficient cash flow to cover your interest ratios.
In summary the lending market is constantly changing and hard to keep up with. For this reason it’s often worth engaging one of the companies that specialise in SMS funding as they will have strong relationships with a variety of lenders, understand each banks current requirements and how best to structure and present your application to provide the best prospect of success.
In my experience the simple answer is “a lot more than you think”. The lack of cash to fund SME growth is the single biggest cause of SME failures and yet it need not be so.
With a proper understanding of business dynamics and risk, cautious budgeting and the regular monitoring of your performance against your budgets you are already a long way along the path to securing your future.
So How Much Cash Does an SME Start-up Need?
THE FIRST STEP
Be totally honest with yourself when assessing your business plans, don’t plan on what you hope will happen, don’t even plan on what you think will happen. Plan on what you know you can achieve and then allow for the unexpected.
Over the span of a long career I would estimate that 80% of the start-up budgets I have seen, over estimate sales and cash flow, whilst under estimating costs and cash burn.
This will possibly frighten you but you should have sufficient cash on hand at the start of your business to cover at least six months of total costs and operating expenses and you should maintain this cover throughout the growth of your business.
If your business concept is realistic and your business plan and budgets well thought through you will almost certainly succeed but be very realistic when budgeting.
THE SECOND STEP
When writing your business plan and establishing budgets calculate the cash needed in year 1 to meet your three key areas of expense; Cost of Entry – or Capital Expenditure (CAPEX); – Cost of Goods Sold – (COGS) and finally Operating Expenses – (OPEX).
If after careful consideration and budgeting the sum is higher than you thought, see what if anything can be scaled back, without losing sight of your concept and what cash is really going to be needed to deliver the objectives.
Do not despair if the cash needed is more than you thought or indeed more than you have available. The cash needed is the cash needed so plan for it.
In respect of Revenues employ caution in the quantum of sales you project. A mistake here will cost you dearly and don’t expect your customers to pay you on time. Most “good” debtors pay in 30 days but it is usually 30 days from the end of the month in which you invoice and if they are savvy buyers they will order in the first week of the month thus getting almost 60 days to pay.
THE THIRD STEP
The business plan and budgets are written and after due and diligent consideration you feel you are short of cash “Stay Calm and Engage Stakeholders”.
The stakeholders in your business include you, your family, your investors, your staff, suppliers and customers.
If your business plan is sound and well-articulated and explained, each of these stakeholders will support you. Your family will probably support you best by understanding long hours worked and tiredness at home.
Your investor in making the decision to back you and your idea has the most to gain by supporting and helping you meet goals. The investor is probably experienced and can be a great mentor and sounding board for you so use the relationship and value it.
Your customers and suppliers both stand to gain through your business success so engage them, show them your plans and discuss the terms on which you need to trade. Treat them with respect and they will return the favour in heaps.
We are yet to answer the big question: Just how much cash does a SME start-up need?It’s a bit like the question; how long is a piece of string and the answer is the same……it’s as long as it is, or it needs as much cash as it needs.
Don’t be worried by this, in almost 30 years of SME experience I have always had access to more investor cash than I have had to good ideas and people to back.
If you have confidence in yourself and your plan and need an investor, speak with local accountants, financial planners and lawyers, they will almost certainly know someone looking to invest funds in a sound idea.
Most importantly if you think you need $8.00 ask for $10.00 it’s much easier to return funds with a little interest than to ask for more. Again if you think your first years profit is going to be $10.00 write it up as $8.00 and come in ahead of budget. Everyone loves a winner and success spreads!
Follow these simple steps and you should be set for a successful future with loyal stakeholders willing to follow you into your next bigger venture.