Bank lending: mission possible?

How to secure debt funding in a downturn by avoiding the pitfalls that make it easy for banks to turn you away

Growing Business looks at the most common mistakes made by entrepreneurs seeking debt funding in a downturn, so you know what to avoid

“We’re still open for business.” The battered banking sector’s refrain of choice when addressing small business customers has been a grindingly familiar one for over a year now. Entrepreneurs will be forgiven for writing it off as hot air; business lending has fallen in seven out of the last 12 months. Whether the consistently weak levels of lending reflect cutbacks in credit provision by banks, or low levels of demand, is uncertain, but both factors are probably at play.

In this climate, and amid stories of profitable, viable companies being turned down for lending and loyal customers having established lines of credit withdrawn, if your firm needs debt finance, whether for working capital or for growth, how likely are you to secure it?

“Commercial lenders are fundamentally looking to lend money in the certainty of getting it back. That means that their risk profile is very risk averse,” says Noel Guilford, the chairman of business lobby group the Forum of Private Business (FPB). To maximise your chances of success when your lender is running scared, the easiest way to get ahead of the pack is to avoid the common pitfalls that see the majority of applications declined. 

How much?

Earlier this year, DVD-by-post firm Lovefilm celebrated securing its millionth subscriber and, impressed by its growth, Lloyds agreed to invest a crunch-defying £10.5m to expand the business, clear off current debts and fund future technologies, including its video-on-demand service.

Chief executive Simon Calver admits securing it was not easy, but the deal is encouraging evidence that there is still money available for the right companies.

While most businesses won’t be looking for debt funding at that level, Calver says firms can improve the chances of success by honing their business plans in preparation for a meeting with a more risk-averse lender. “You might need a revised plan that’s more sustainable, or with more emphasis on what is unique and different in what you offer compared with others,” he says. “Investors are being a bit more cautious and need to be certain they’re backing the right idea, so your own expectations need to be different.”

The good news is that there are enough entrepreneurs presenting untailored or poorly conceived plans to make yours look desirable. The first mistake to avoid is failing to know exactly how much you want.

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“When people come and see us, they often haven’t thought things through,” says Mark Prater, a corporate finance expert and partner at Quantum Partners, which helps fast-growth technology firms raise both debt and equity finance. “They see money coming in as a big lump sum. In the current climate, people aren’t going to advance money for a war chest.”

Counter-intuitively, it could be a mistake to minimise the cash requirement. “Firms might go out and say they need £100,000 of funding, but actually, when you dig a bit deeper and look at the business proposition properly, you find it needs £500,000. All they’ve done is prove the initial requirement, but it doesn’t take them through to anything that’s cash generating or self-funding.” Don’t take the short term view which solves your immediate problem but won’t deliver sustainable growth, Prater advises. 

What for?

Simon Baker recently founded advisory firm 3Cube to help entrepreneurs gain funding through the much maligned Enterprise Finance Guarantee (EFG) scheme, under which the government acts as a guarantor for 75% of bank lending to viable businesses to help meet their working capital requirements. One company his firm successfully helped had initially been turned down on the back of confused spending projections. “Companies always forget where the money’s going to be used,” says Baker.

“This particular company wanted to raise £500,000. That’s fine, but where’s the money going to be used? Banks won’t provide a contingency fund,” he says, echoing Prater’s point.

Whether you’re applying for the EFG or conventional bank funding, break down the amount you want into component parts and put what Prater refers to as a “road map” in place. This will tell the bank where the money will be spent and in which time parameter. Once you’ve decided exactly how much you’re asking for, structure your proposition to show when and where the cash you’re borrowing will be spent.

Hone the plan

A move away from traditional relationship-based banking into high risk financial engineering not only did for the banks’ balance sheets, it also made it much harder for them to understand their small business customers, Prater argues.

“It’s very difficult to deal with a knowledgeable person because very often, you’re just dealing with call centres,” he says. “The banks are finding it difficult to get to know the business and are therefore finding it difficult to place money because they don’t know what half of them do.”

While it’s arguably advisable to simply build or retain a relationship with a bank that has “stuck to the knitting” (broadly stuck to old fashioned relationship management and taken a relatively prudent approach to risk) you’ll need a bulletproof business plan wherever you’re looking for funding. It’s an area where entrepreneurs come up short all too often.

“Business plans tend to be pretty rubbish and financial modelling tends to be pretty poor,” says Prater. “It comes down to the business plan making things as easy as possible for the bank.”

The bank will have access to detailed market analysis, so you need to show your knowledge of the market and how your proposition fits in. “You must have some element of proper market analysis in there – show them why this is a great market and a good opportunity. What is the business proposition? Where is the long term growth? People just ignore these things and assume their idea is the best ever.”

Break your cash requirement down into the short, medium and long term, and if debt finance doesn’t cover any of those three scenarios, explain how the extra finance is going to be raised. And if you’re asking for funding that you think marks your company’s maturity, don’t make the mistake of assuming you’re already approaching the exit. “You get people that wrongly assume they can get the most expensive company car on day one. It’s small things like that which undermine confidence. The entrepreneur has to give the impression of long term commitment.”

All projection

Your revenue and cashflow projections will need to be bullish yet realistic. Les Lockwood, chief executive of growing laser technology firm Powerlase, believes his bid for $5m of bank funding was partly undone by some unrealistic projections made by his predecessors: “Before I joined in 2005, one of the management team made some pretty bold projections and never met them,” he says.

Lockwood also believes the bank was put off by the fact that the firm’s clients are all blue-chips. “They felt the budget cycles would have been a risk,” he concedes. Unsurprisingly, he believes the bank made a “huge mistake” and the firm has since successfully raised the funding from VCs.

His experience does highlight the importance of making your projections as accurate as possible, but for all the market analysis, most entrepreneurs will acknowledge a lot of guess work is involved, so have a contingency plan.

There has been widespread coverage of banks renegotiating existing facilities at a higher cost to the customer upon renewal. However tempting it is to point the finger at capricious bankers, you have a business planning responsibility here, too. “If you know that you’ve inadvertently breached some of your financial covenants then you need to speak to somebody who can assist you in putting a good case to the bank as to what’s going to happen going forward,” says Chris Langridge, head of corporate finance at law firm Cripps Harries Hall.

Whether you’re worried about having established lines of credit withdrawn or are approaching your bank for new funding, telling a good story is crucial. “You might have breached your covenants, but say ‘here is our best and worst case scenario over the next year, and here are the plans we’re ready to put into action if we need to’. It’s about preparation,” Langridge adds.

If preparing your plan forces you to take a view on how you’re utilising your resources, that’s no bad thing, says Prater; after all, the banks will be taking a close look. “Sensible planning is part of proper business models. Challenge your model constantly to make sure you’re robust and profitable. We see companies who have five sales people attacking the corporate market and five attacking the SME market. Where’s the sense in that?

“If you can penetrate large corporates where there’s more value in the contracts, why mess around with low-margin, small stuff?” he asks. “And what impact can five salesman have in a market of 100,000 SMEs? It’s using your resources properly.”

Have a tough appraisal of projections, cashflow and cost management before you put them in front of a lender.

The right party

Even if your business plan is rock solid, if your sector isn’t currently in vogue with your bank, you’re probably going to struggle. A carefully-chosen adviser should point you in the right direction.

“If your existing bank considers your sector ‘non-sexy’, they might not be willing to invest in that sector however strong a case is put forward,” says Langridge. “Another bank may take a different view. It may be worth talking to a corporate finance adviser or accountant who has a number of contacts to see which banks are interested in your sector this week.”

Many a successful entrepreneur has done alright by the ‘don’t bet the house’ mantra, but with banks increasingly asking for personal guarantees, if the media scare stories are anything to go by, you might be forced to reconsider. But don’t panic: the 100% personal guarantee is far from the norm.

“If the business is a bit shaky, there will be occasions when they ask for personal guarantees,” says Baker. “But we will sit there and explain why it’s being asked for and how they can be released going forward if certain things are done.”

The funding environment remains forbiddingly tough, but strong, viable businesses that can present themselves in a sensible, structured fashion are likely to default to the front of the queue.

“Entrepreneurs always get blinkered,” concludes Prater. “They think they’ve got the best idea under the sun and everyone will want to buy into it. They might do, but you’ve got to give them a reason.”

Hot seat
Mark Priestley, client partner within the entrepreneurs client group at Coutts, offers his tips on giving your pitch for funding the best chance of success
  • Write a good business plan and don’t turn up with just an idea – get it down on paper including financial projections. Corporate bankers read myriad business plans and are good at ignoring the waffle (your sales pitch). They are only interested if the numbers are realistic
  • Turn up with an accountant or professional adviser. A well respected accountancy firm can add value to your business plan if they have already done the number crunching
  • Risk should equal reward so be prepared to pay higher interest margins and fees if it’s a new venture; the risk of default on the loan will probably be higher
  • Do your market research first. Banks hold up-to-date information on most sectors, which they may have read before you go and see them
  • Tell them who your competitors are (they may already know from their research) and how you will differentiate your business
  • Be prepared to offer security such as your house or fixed assets. A bank is being asked to take the risk of investing in you and will want recourse to your assets if the venture fails. By putting your assets on the line, this should be reflected in the interest rate you will pay
  • Be prepared to negotiate but remember the bank has something you want, so don’t be too aggressive and end up with nothing



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