Bank funding

This is the first in a series of posts about business funding.

Ever since the world’s bank stopped lending to each other in August 2007, many small firms have found it very difficult to get the finance they need.

There are two types of facility offered by the bank, an overdraft or a business development loan.

It is best to use overdrafts for temporary funding. For example, if the cashflow forecast shows a shortfall for 6-9 months.

If you require a longer-term facility then consider a business development loan. This is because the rates are lower for a loan, and with an overdraft you’ll need to rearrange it every year which takes time and energy.

Bear in mind that the money you need could be a mixture or short and long term funding so consider splitting this in the cashflow forecast.

Whether you apply for an overdraft or a loan the banks will be looking for five key things:

First, there is serviceability. The question on the banks mind is “can the business generate cashflow to cover the repayments?”

This will often come down to a sales forecast so it helps to have extensive market research, a detailed marketing plan, letters of intent from prospective customers or better still signed orders.

Second, the bank will be looking for security to back the lending.

If the business cannot afford to repay the debt how will the bank get its money back? Banks will usually ask for personal guarantees.

Are you prepared to risk your home to fund the business?

Third, the bank want experience; a proven track record and being involved in the industry will go in your favour and against you if you launch a business in a sector you have not worked in.

They will also value business experience of running a company and will like to see a strong management team.

A bank will like a business to have an accounting system, budgets and management reporting in place. Often the bank will insist on management accounts being completed as part of the condition of the facility.

Fourth, the banks are keen to see other funding which they can match.

So, if a business needs £20,000 they are more positive about lending £10,000 if there is £10,000 coming from elsewhere.

Banks like to see other investors or grant funding because it shows other people are backing the business.

Fifth, a bank will required a comprehensive business plan with cashflow, profit and Balance Sheet forecasts for three to five years.

Many banks have their own business planning software or templates that you can use.

However, whatever the banks say (or don’t say) they don’t like risk.

If your business has yet to file accounts or has a trading record of just a few years, the banks will consider you a very risky project.  And, if you’re still at the pre-revenue stage the perceived risk rises through the roof.

The caution of banks can slow down the whole lending process. Even if a bank does eventually advance the cash your business needs, the gap between the initial application and the green light can stretch to months.

But, if you think about this from their perspective it is easy to understand.

Keep in mind that if you apply for a facility of £10,000 over five years at 8% they will generate a little over £2,000 of interest.

This is the banks total revenue and from the arrangement from which direct costs and overheads need to be deducted. If it is an overdraft this could be an annual review so the profit on the deal may be as low as £1,000 or less.

Also bear in mind that the bank gives you the money today but they their profit over five years, so inflation makes the interest worth less.

So, one bad debt can eliminate the profit from one manager’s portfolio.

To help encourage lending to businesses the Government have a number of schemes.

The three schemes we will look at for this presentation are:

• The Enterprise Finance Guarantee scheme
• Export Enterprise Finance Guarantee scheme
• Community Development Finance Initiatives

The Enterprise Finance Guarantee scheme replaced the old Small Firms Loan Guarantee scheme.

Launched in January 2009, the loan scheme provides a government guarantee to help boost the credibility of small business loan applications.

Although established small and mid-sized companies have benefited the most from the scheme, start-ups in the first three years of business account for 37% of all loans offered, with 17% attributed to businesses within their first three months.

Like any normal lending arrangement, the cash for an Enterprise Finance Guarantee loan comes from the bank but the government will underwrite 75% of the loan.

In theory this means you have a chance of securing a business loan even if you don’t have the collateral to back it up.

Loans range in size from £1,000 to £1m, and the time span can range from three months to 10 years.

You can choose to receive the loan in a lump sum, or break it up into regular chunks to suit your business strategy.

The scheme is designed to suit all sorts of needs and circumstances. You can access the finance to:

• Increase a company’s working capital
• Refinancing an existing loan
• Convert an overdraft into a term loan

In addition to the standard capital and interest payments demanded by the lender, Enterprise Finance Guarantee loan recipients have to pay a premium to the Department for Business, Innovation and Skills.

This is usually equivalent to 2% per annum on the outstanding balance of the loan, and is assessed and collected quarterly throughout the loan’s lifespan.

Although this is a Government scheme, the decision on whether or not to grant a loan using this scheme is wholly delegated to the bank; the government does not have a say.

Like any loan application, an Enterprise Finance Guarantee loan requires an application and a raft of supporting documents, including a business plan, management accounts and financial projections.

The Export Enterprise Finance Guarantee scheme is similar scheme exists for businesses that trade overseas but the scheme only covers 60% of the loan.

Community Development Finance Initiatives are loans that are delivered on a local level and are for deprived communities. A Website will help you find an initiative in your area www.FindingFinance.org.uk.

The pros of Bank Overdrafts and Loans are:

• The loan is not repayable on demand and so available for the term of the loan.
• You do not have to give the lender a percentage of your profits or a share in your company.
• Interest rates may be fixed for the term so you will know the level of repayments throughout the life of the loan.

The cons of Bank Overdrafts and Loans are:

•  Larger loans will have certain terms and conditions that you must adhere to, such as giving the bank quarterly management information.
• Loans are not very flexible – you could be paying interest on funds you’re not using.
• You are likely to need to provide a personal guarantee which puts your home at risk.

But, banks are not the only game in town so the next post will explore funding from customers and suppliers.