Have you ever tried to get a business loan from your bank? What was your experience like? Most small business owners I ask these questions give depressing answers: frustrating, nightmarish, not very palatable.
Their frustration usually begins from the complex application process to the stringent conditions the banks would require them to meet. Their conclusion always come to this: banks do not lend to small business owners. I will rather say that banks are reluctant to lend to small businesses. You will soon get to know why.
The major business of a bank is to get money from people who have, give to those who don’t have and make some spread in the process in the form of interest. That is what financial intermediation is all about.
If you look at the balance sheet of a typical bank, you will see that business loans and other classes of loans constitute the major source of income. That is why they are called lenders. If granting loans to customers are of such importance, why then should banks not give business loans to small business owners.
To appreciate why banks are reluctant to lend to small businesses, it is important to understand the way lenders think. Banks pay particular attention to the risks associated with lending an for more particularly so, for a business loan request. From the perspective of the lender, every borrower has an associated risk – the risk that the money given to the borrower will not be paid back on due date or not paid back at all.
An assurance that a borrower will repay a loan is very important to a financial institution. This is because credit facilities are granted to customers from depositors’ funds based on the lender’s assessment of the borrower’s cash flow as being sufficient to repay the loan on or before the depositor asks for his money.
In order words, a bank will only give you money if it is convinced that you will pay back so that the bank will be able to pay its depositors their money on demand. The risk in lending, thus, is the chance that borrowers may default on the loans while customers deposits must be paid on due date.
This is the risk that banks try to mitigate by critically considering certain factors before deciding to give loan to any customer. Unfortunately, this risk seems to be higher with small business operators. It need not be if owners of SME’s know how to package their businesses to reduce these perceived risks.
In accessing a business loan application or any other type of loan for that matter, Banks use a set of criteria to decide whether or not to grant a loan request to an applicant. These criteria are technically described as cannons of lending or the qualities of a good credit. Banks want to lend but they want to give our quality loans that will be paid back. Unfortunately, most micro, small and medium businesses, usually do not meet these credit criteria.
Let us look at some of these criteria briefly; call it a check list if you wish.
Character of the Borrower: This has to do with a borrower’s integrity, honesty, industry and reputation.
Is the borrower one who keeps to his words? What are his values? What drives him? The bank will want to know if you have a track record of loan repayment or are you a serial loan defaulter. Good character is of essence in credit consideration. Where there are doubts about your character, no bank will lend you money.
Trained credit analysts will usually form an objective opinion about a borrower’s character during the credit interview and on the review of a customer’s application documents. The reason, banks’ credit application form appears to be long and tedious is because they want as much information as possible to enable them form an opinion of the applicant.
In addition to the assessment by internal staff, Nigerian banks and other financial institutions also make use of Credit Bureaux for third party confirmation of the credit character of would be borrowers. Credit Burueax are firms licensed by the Central Bank of Nigeria to maintain a credit register of borrowers for the Nigerian financial institutions.
Capacity– the bank wants to be sure of your ability to generate enough cash from your businesses to be able to repay the loan plus interest.
Financial capacity can be ascertained from your financial statements, if yours is an existing business, as well as your bank statement of accounts showing how money flows in and flows out. If yours is a startup, then your business plan has to contain a convincing cash flow projection which shows that you have done a detailed analysis of your business operations.
The lending institution may also want to ascertain the legal capacity of the borrower to enter into such contract. In this case, how you organize your business will matter.
Are you a sole entrepreneur operating from home or are you in partnership with other people, or is your business a limited liability company? If you are a sole proprietor, are you up to legal age of entering into a business contract, amongst other relevant questions.
Capital– This refers to the level of investment the borrower has in his business. The bank wants to know if your interest and commitment in terms of your investment is adequate to absorb business risks or shrinkage in assets. It gives them the assurance that you will not just pack up your business and disappear at the appearance of the slightest difficulty.
Condition – These are the things you are required to do before you draw on the loan granted. Usually they will include a proper execution of loan agreement, acceptance of the offer, provision of documents that may be required and inspection or confirmation of collateral as the case may be.
For a business loan, additional requirement such as properly executed resolution of the board of the company authorizing the request, may be required. This is why it is important that you institutionalize your business by putting proper legal and operational structures in place.
Collateral – this is a pledge required by the lender as additional comfort that you will not default in repayment. It can also be treated as a secondary source of repayment should the primary source fails.
Your primary source of repaying the business loan your bank has granted is the ordinary activities of the business itself and the level of cash flow it generates. It is your income and profit and the bank want to be sure that your business has the capacity to generate enough income to pay its debt as well as leave some profit for you.
It Is Not All about Collateral
Ask an average small business owner why he is not approaching his bankers for funds and he will simply tell you that he does not have collateral. Many people see collateral as the major criteria upon which a financial institution will lend. The reality is to the contrary.
Collateral, be it landed property, machinery, vehicle or whatever of value that a lender may ask you to provide, only serves as additional comfort. Something the lender will fall back on should it become practically impossible for you to repay the loan.
Banks are not in the business of selling houses, or cars, or commodities. In fact they do not have the competence to do these things and are very happy with borrowing customers who repay their loans promptly such that the banks will have no need to recourse to the collateral pledged.
Now let me spell it out clearly, your bank would not give you a business loan for the reasons listed below:
- You failed the credit appraisal criteria or test.
- Your Business is not properly structured
- You don’t have good record keeping system
- You cannot produce believable or sufficient cash flow projections
- You probably do not have a good business plan
- You could not provide enough comfort in case things go wrong
These are a few personal checklists. The short of the story is that, bank will only lend to customers who meet their credit criteria.
Therefore, your first step to getting your bank give you a business loan should be to understand what these criteria are and package your business in such a way that it will be attractive to lenders. Many micro, small and medium businesses are found wanting in the way they organize their businesses, hence are unable to meet the fundamental requirement for bank funding.
Now that you know, take the right steps!