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.
Most SME operators tend to think that good management, innovation, hard work and productivity will result in a profitable business, well they should but that’s not the whole story.
Not all profits are created equal and indeed some are much more valuable and more quickly and easily attained than others. Ah there must be a catch I hear you say; there is no catch but understanding the Three Profits of SME will make a significant difference to the way in which you view and manage your business.
The First Profit
The First Profit of SME is the easiest profit you will ever make and could account for a substantial amount of the total profit your business generates over its lifetime. The First Profit flows directly from your cost of entry.
Once you decide on starting or buying a business be it a hardware shop, bakery, call centre, IT service or a property development, do your research. Look around for a similar business in distress or even facing or in administration or receivership. There are many reasons businesses fail but most often its insufficient cash or poor management, if you are a good manager and you have cash get out there and buy well.
Most businesses fail within the first two to three years. I have bought near new businesses out of distress for less that 10% of the cost of establishing that business. Plant and equipment as new, some customers in place and ready to go. If you can run that business and cash flow it you make a 900% profit in your first 2 years because well run the business should be worth at least its true set up costs.
The Second Profit
This is the only profit some people think of; the operating profit that flows from good management, business planning, innovation, hard work, productivity and sales effort. The Second Profit most importantly sustains your cash flow, pays the bills, allows you to further develop the business and should leave you with a healthy profit after drawing your wages.
The real key to the just how large The Second Profit is relates to the lessons of the First and Third Profits. Put simply the keys to strong operating profits are how well you control the cost of the goods and services you offer and how well you price them.
Do the maths. You are much better off and your business is stronger selling a lower number of products or services at a higher margin than going for volume at a discount.
Look for ways to offer a significantly better service to your customers than your competitors are and lift your prices. Treat cost controls and buying as seriously as sales, manage your stocks to achieve maximum stock turn at minimum inventory. Establish and monitor your KPI’s. Motivate and reward your staff. Build a happy and united team.
The Third Profit
This Third Profit if planned carefully and executed well will bring you a profit as relatively easy and large as your First Profit. We are talking here of your exit strategy, the day you sell your business. Whilst this seems a long way off when you start your business you should be planning and working towards the exit every day.
The Third Profit will directly reflect the desirability of your business to a potential buyer. That buyer will need to be very comfortable with your business if you are looking for a premium priced exit.
From day one work to a detailed financial budget and business plan, report against it monthly; draw up detailed monthly accounts, (it’s so easy today), hold monthly board meetings with an agenda and minutes, even if the directors are you and your wife. File all tax returns and corporate documents on time and constantly update your corporate register. Imagine how comforting 3, 5 or 10 years of such well-maintained records are to a potential buyer.
Lock as many customers as you can onto long term supply or service contracts and do the same with your key suppliers. Look after, reward and motivate your staff so that your retention rate will be high. Another three prospective purchaser concerns answered.
Typically a purchaser will offer a multiple of earnings (EBIT) plus stock at valuation as a pricing mechanism. If the accounts, customers and staff look ad hoc the multiple offered is going to be between 1 and 2 times earnings and stock over one year old will be discounted to $0.10 in the $1.00 and over six months old $0.50 in the dollar.
With solid accounting, tax and corporate records, good budgeting, a regular stock turn, sound supplier and customer relationships, and loyal staff a potential purchaser is going to look much more favourably on your business and a multiple of 4 to 6 times EBIT plus SAV at full cost is a likely outcome.
Another strategy is to approach your major competitor; a consolidation of the two businesses could bring about significant efficiencies and cost benefits thereby lifting to value of your business to a multiple of 6 to 8 times EBIT.
I hope you take on board The Three Profits and prosper from them. Good Luck!