Common Loan Mistakes Of Small Business Owners
Monday, December 7, 2015
Be ready to mix it up to get bank funding
Approaching your bank for a loan is often a make or break event for a small business, yet it’s one area where many owners slip at the first hurdle.
Several experienced business advisers were approached for their thoughts of what business owners need to do to improve their chances of securing bank funding.
The point made by all of them is that banks will always lend to good businesses, and a line of credit is a favoured product. Business owners, however, need to be open to different forms of funding – or a mix of bank products.
Mark Holton, a director of Smithink Advisory, says that banks are looking to lend every year.
“Each year their borrowers pay off a component of the principal loan amount,” he says. “Hence the bank needs to replace this – that is, to lend the same amount as the year before – just to keep making the same after tax earnings that they made last year.
This makes banks keen to lend – but to the “right” borrowers.
“Banks will look at a whole lot of factors but in the end it comes back to quality of cash flow and capacity to pay,” says Holton.
“Business owners and their advisors need to be able to clearly and compellingly articulate why their lending proposition should be supported by the bank.”
For him, the starting point is for a business owner to find an accountant able to assess “pre-lending suitability” and to monitor whether or not their clients’ current numbers are shaping up to their bank's expectations.
“Taking one step back, and a fundamental question to ask is can your business sustain the current debts before taking on another loan?”
This allows the business owner to be ready to go well before they approach their bank.
“There are plenty of sophisticated financial analysis tools. These will allow predictions of where the business will be over the next three, six, or twelve months, and to do something about emerging weaknesses,” Holton says.
Partner with your bank
Paul Bakker, lead partner of business advisory for Crowe Horwath in Sydney is seeing more lending activity. His accounting firm has one of the largest small business client bases in the country, so that gives him more insight than most into what works.
For him, any uptick in lending will come about in part because more business owners are starting to understand how debt affects their business, and therefore the importance of the banking relationship.
"After 17 years in the business, I'm seeing a different approach from banks," he says. “Now I'm seeing a different language and a different approach; it's a willingness to have a deeper understanding of the client’s needs, and really delivering to those needs.
“It’s better to have the bank as a partner in your enterprise, than just a source of funding to be tapped.”
By way of anecdotal example, Bakker has a client who had been in business for three years, “so had a bit of cred", for short-term funding options to finance expansion.
“Being a traditional accountant, I was thinking of something like a mortgage-backed loan or a business line with tight caveats,” he says.
“Instead, the bank suggested debtor factoring, given the nature of the client’s business. It wouldn't have been my first port of call, given that the business had only been going for two or three years, but the bank liked the sector that they were operating in, and were very impressed at the type of client they had attracted.
“The bank brought the solution to the table and, in fact, it improved the business. The bank took a leading role in engaging with suppliers, visiting them with my client and discussing the terms and conditions they had with my client. “
Result: the bank was confident that the financing terms and conditions would be met and the client had a more secure supplier base.
Bakker’s comments gel with the views of Nathan Keating, the managing director of debt advisory firm, Pearl Financial Service.
“You need to have to have a clear articulation of what the exciting future of your business is,” says Keating, a former banker turned adviser.
“The counterpoint to that is that the banker is trained to recognise BS, so any approach to a loan needs to be backed by reasonable justification.”
Keating says is the best way to scrub up for a loan presentation is to put together a three-way forecast – that is, a profit and loss, balance sheet and cash flow projections.
This is because banks will be more interested in what is known as "first way out" – the cash flows of the business to pay the loan.
“The bank will also look for ‘a second way out’, if the business doesn't go as well is expected. Unless you can supply the bank with a second way out, you're going to struggle,” he warns.
“And don't forget that the stock on your shelves is not normally considered a good ‘second way out’ as banks know that stock is not usually worth its book value in a liquidation sale, if it came to that. So if you've built a business around a fad, then you might have to answer some hard questions.”
Use your debtors to best advantage
One area where banks are comfortable funding is via the debtors on your balance sheet as that's a much more liquid asset, according to Keating
“Many banks have trade finance products that are worth discussing, possibly in combination with a loan bank by debtor security,” he says.
And businesses in the services sector that invoice with trade terms that banks can lend against will be able to access bank finance. “Recruitment is a terrific industry for debtor finance – as long as you have an invoice for services you can try to fund,” he says.
In contrast, manufacturing has become a difficult sector. “You need to convince the credit department of your bank that what your products are likely to be manufactured in Australia for the medium term – in other words, your market is not going to suddenly move to China.
“Once you do that, however, you might find the bank is very supportive, particularly as this type of lending often involves equipment finance,” Keating says. “You might also need to import raw materials, so the bank will be keen to show you their trade finance products.