“We have certainly seen a lack of borrowing appetite from SMEs in recent years, mostly because of the uncertainty surrounding Brexit”, says Rob Warlow, founder of SME loan broker Business Loan Services. “There is a huge amount of pent up demand for loan capital. The expansion plans are there, ready to go, but businesses are waiting for more political and economic certainty.”
Hopefully, with the decisive result of the recent general election, more businesses will now pull the trigger on their plans. According to Rob, the supply-side is ready, with lenders keen for more business.
For those SMEs looking to borrow, his hottest tip is to start the process early, ideally 6-12 months in advance of submitting an application. This will allow time to research all options, target the most appropriate lenders, and tailor the business and loan application so that the chances of success are maximised.
Below, Rob shares his thoughts on some common reasons loans are declined, and how SMEs can avoid this fate:
1. Approaching the wrong lender
In recent years, two very distinct groups of lenders have emerged: banks and ‘fintechs’. Traditional banks now mostly avoid small loans (as a rough rule of thumb, below £25,000). Meanwhile fintechs, such as peer-to-peer lenders, dominate this end of the market.
Banks have more manual loan application processes (in a low interest rate environment, small loans are simply uneconomical for them), while fintechs tend to have highly automated on-line processes that are strictly ‘rules-based’.
So SMEs need to target lenders who are comfortable with the size of loan they need.
It is also important to find out which lenders are active in your sector. Banks and other lenders sometimes avoid some sectors altogether – for example, obtaining credit can be quite difficult at the moment for high-street retailers, restaurants and the leisure sector, which have seen higher levels of stress as a result of general uncertainty. Also, lenders tend to allocate a fixed amount of loan capital to each business sector, and may have ‘maxed-out’ their lending capacity.
It is worth having an early conversation with target lenders to make sure they are active in your sector.
2. Poor credit history (of the business or its directors)
Because of their automated processes, credit scores are especially important to fintech lenders. Banks will sometimes dig deeper into the reasons behind a low credit score, but an automated process just looks at the score itself and a decision is made.
Businesses therefore need to make sure they maintain a healthy credit history. Some of the common causes of lower credit scores include: late or last-minute filing of accounts (there can be a few days delay between when accounts are filed and when they are available for credit scoring algorithms to read, so the algorithm may assume accounts are late if they were only filed at the last minute); late payment of invoices (reporting late payments to credit scoring agencies is becoming more common – this puts a black mark against the name of the late-payer); and judgements or payment defaults against the company (a CCJ has a significant negative impact on a credit score).
The personal credit history of directors and large shareholders is also important. Lenders will often be relying on the personal guarantees of directors and will want to make sure they are in a solid financial position.
3. Financial weaknesses
Especially in the case of larger loans, lenders will be studying certain financial metrics. They will look at how profitable the business is, that it is generating enough cash to easily cover loan repayments, and that there is not too much existing debt on the balance sheet.
Importantly, businesses need to be aware that lenders will want to look at the filed annual accounts as well as up to date management accounts. With the advances in accounting software available to SMEs today, it will be expected that all management accounts are fully up to date.
An additional point businesses need to look out for is that sometimes accountants will (quite legitimately) structure the financials to minimise profit (and consequently, tax). But this can work against a favourable lending decision. Planning ahead and structuring the financials to suit a loan application well in advance will be necessary.
4. Issues with bank statements
Particularly for loans above the ‘automated’ assessment threshold, lenders will be studying bank statements and reject applications where repeated patterns of bounced cheques or unplanned overdrafts are evident.
5. Applying at too early a stage
Start-ups are generally a no-go for debt finance, due to their higher risk and lack of trading record. As a rule of thumb, debt finance can be considered after 12 months of trading history has been established.
A final point Rob flags for SMEs is to be prepared to provide lenders with collateral. Online platforms issuing smaller loans will generally only require directors’ personal guarantees as collateral. But for larger loans, collateral such as property or machinery (typically with a value of at least 75% of the loan) will be needed. In some cases, the debtor’s book or stock can be used.
This article is written for the St James’ Place Entrepreneurs Club newsletter. The opinions expressed by third parties are their own and are not necessarily shared by St. James’s Place Wealth Management.