By Edward Napper, audit manager at Peters Elworthy & Moore
There is no doubt that pre-recession bank finance was readily available. During the good times deals were typically completed within three to four months from first enquiry - with conditional offers often achieved within 48 hours.
Contrast this with the current status quo, which has seen banks' due
diligence procedures rebound towards the other end of the scale. The lending environment has now shifted towards high-level policy, with relationship managers afforded less discretion on the ground.
According to Alan Kean of CMAK Finance, local finance brokers: "The average
period between first enquiry to loan draw-down has now risen to nine
months". Quite apart from the far greater proportion of loans refused in the
first place, this has a real cost to business owners, who are unable to
respond quickly to opportunities.
So what factors are critical to the banks in approving credit? The first is
the presence of an established business. This leaves new SME start-ups out
in the cold; the most common source of finance for such businesses remains
the owners' equity or private investment from friends or family and, in
reality, it seems that the best start-ups can hope for in terms of outside
funds is to attract some venture capital interest.
Some help is available from the Government Enterprise Finance Guarantee
Scheme (EFG), under which the Government guarantees 75% of the loan where
the business has insufficient assets against which to borrow - however, to
date the EFG has only really been used by established businesses.
In terms of financial results, banks want to see a profitable track record,
typically over a minimum of three years and with little or no significant
deterioration (even during a recession), so-called "sustainable
Businesses with seasonal or cyclical trading cycles are not favoured and
banks will usually apply a generic sector risk, which although very wide, in
many cases will still affect lending decisions. There has also been a
definite shift from a safety model (loan cover, asset cover, and so forth)
to a viability model, which focuses on assessing the serviceability of debt.
Banks will usually start with EBITDA (earnings before interest, tax,
depreciation and amortisation). Business owners can estimate their own
interest costs, however banks will tend to apply a "stretched" interest rate
to reflect uncertainty, so there is often an expectations gap in terms of
the cost of funds. It therefore follows that businesses can sometimes access
a better covenant through a fixed loan because stretched rates are not
applied. Typically, banks require an EBITDA of between 130% and 200% of
annual loan repayments, which will vary according to sector risk and asset
Negotiating a loan
Some of these factors will be beyond the business's control and indeed focus
on actual historic data, but there are some basic measures that can be taken
to maximise the chances of securing finance:
Owners should first hone a slick and professional presentation from day one
and in particular ensure an in-depth knowledge of historic trading results
as banks will expect them to have answers to hand.
Attention to detail and to presenting key data accurately is critical. Banks
will check personal bank statements to verify information disclosed and any
inaccuracy, even from small and careless errors, can register as a black
mark and damage the reputation with that bank.
Robust cash flow and trading forecasts are of course essential and owners
should present the best business case as banks will apply their own risk
factors to substantially dampen predicted results. Chris Mason of CMAK says:
"Expect your bank to reduce your forecasts by at least 10%." So your
forecasts will need to stand up to scrutiny.
The importance of close bank account control and a clean credit history is
also paramount. Even a single bounced cheque will damage the credit rating
and may result in finance being rejected.
With recessionary pressures causing many businesses to miss payments, breach covenants or exceed overdraft limits, any leniency from the banks has
passed, with heavy financial penalties now being applied, in many cases
where technical breaches had gone unpunished in the past.
Indeed, fees for agreeing some change in borrowings in advance are, as a
rule of thumb, cheaper than penalty fees, and businesses not adhering
strictly to existing agreements should expect only the harshest treatment.
By applying severe penalties the banks are responding to deterioration in
the behaviour of the business and what they want to do above all is to deter
that behaviour. The best advice is therefore to closely monitor your
business finances so you can have early-stage discussions with your bank if
there are changes in circumstances.
Some positive signs
In spite of the continuing gloom associated with the Eurozone crisis, there
are a few positive signs. In his Mansion House speech earlier this year,
George Osborne announced plans for an emergency bank funding scheme to
kick-start lending to households and businesses.
Under the Funding for Lending proposals, British banks - facing higher
funding costs and under pressure to put more capital aside - will be offered
short-term borrowing from the Treasury at low interest rates. The hope is
that these measures will encourage lending to businesses by ensuring
liquidity is more easily available to banks.
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