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|The Classic Loan Application Mistakes SMEs Make|
|Monday, 19 September 2016|
WHEN a business owner looks for external finance they are generally thinking one thing: I need money and I need it now. But too many fail in their efforts to find funding for silly, obvious, and easily avoidable reasons. It is quite common for a loan application to be rejected not because the company is undeserving or inappropriate for financial backing, but simply because the case for borrowing was made badly, or a funding profile was presented that few funders would support.
By Alex Littner, Managing Director of Boost Capital
Lenders regard and assess risk very differently. Most mainstream banks take quite a cautious view, looking for businesses with a proven track record that have traded for a few years, and also demonstrate steady growth. Relatively new enterprises, those that appear to be expanding too quickly, or those operating in fields that appear risky to the uninitiated – exporting to China, for example – can meet with resistance from conventional lending sources.
The new generation of alternative finance providers are often more flexible in their approach, but their attitudes towards risk vary, too. But there are certain classic mistakes business owners can avoid when making an application, and ways to improve their chances of meeting with a favourable response from most funding sources.
How much is enough?
The number one mistake SME bosses make when putting together a loan submission is asking for too much money. That isn’t to say there aren’t lenders willing to release sizeable sums to firms with ambitious plans for growth, or to those with a legitimate need for a big tranche of investment capital. But when a business owner demands a huge loan that seems to have been arbitrarily calculated, most funding providers will hear alarm bells ringing.
A general rule of thumb is that a sensible business will ask to borrow between ten and 25 per cent of its annual turnover. Those that start out by asking for 50 per cent with no concrete justification for the amount requested are likely to meet with derision and, ultimately, disappointment. Any loan assessor wants to see that those borrowing understand exactly what the money is needed for, and how they have costed the loan. A back of the bus ticket calculation won’t impress anyone, and will almost certainly be rejected.
Too little, too late
Another classic error too many business owners make is waiting until they face a financial emergency before applying for external funding. Being in a desperate state is not ideal when putting together a loan application for a variety of reasons.
There are many funders these days that can process applications, make decisions, and release money quickly, but the banks and conventional lenders typically still have slower processes that can take weeks to go through – bad news for an enterprise that needs capital immediately. Also, hurried applications are often ill-judged, poorly prepared, and unrealistic in their expectations.
The sensible entrepreneur will constantly keep a weather eye on what’s happening in their company not just now, but in the weeks and even months ahead. Someone who is properly organised and has a good handle on their cashflow will be able to spot a funding crisis or a probable need for future investment some time in advance. With this foresight, a business owner can then be thorough in researching potential funders, as well as taking time over the loan application itself. It is also wise not to submit an application at a time when a business is experiencing any instability, such as a restructure or change of management. Lenders are often wary of taking a gamble on a company in a state of flux.
Not grasping the numbers
Having a poor credit record certainly is a major hindrance for SMEs attempting to gain a conventional bank loan. Not all lenders rely on this crude measure when assessing a company’s financial wellbeing – we at Boost Capital, for example, prefer to look at monthly gross sales and the company’s ability to generate revenue rather than a simple credit score. But an enterprise’s credit history is often important when it comes to applying for external finance, so bosses should know what their credit profile says, and how that’s likely to affect lenders’ decision-making.
Businesses should be ready to share financial data such as management accounts, details of cashflow, and any information that’s reflective of the firm’s overall health. The reason funders have traditionally relied on credit scores is that it can be hard to judge the risk of lending to a small entity whose financial data are disorganised, incomplete, or simply unknown. Using accounting software has improved this situation, making SMEs’ ability to keep their financials up-to-date much easier. It also means finance providers can easily tap into this merchant data, which gives them a far clearer picture of how a company is really doing. Whatever it takes, be on top of your numbers. Demonstrating poor understanding of the fundamental figures relating to your business is a sure way to funding rejection.
Taking the most obvious route
It’s a fact that’s often repeated, but the UK’s big four banks account for nine out of ten SME loans, the Competition and Markets Authority has found. Six out of ten SMEs spend less than an hour researching their lending options. And seven out of ten only ever approach one funding provider when seeking a loan. This inertia seriously limits businesses’ probability of getting the finance they need, as the banks can be quite rigid in their loan criteria. Plus, small firms are missing out on the myriad of new borrowing possibilities now on offer.
British SMEs lose out on £20 billion annually due to lack of awareness of alternative sources of business funding, according to GLI Finance. The high street banking institutions may seem the most convenient source of borrowing, but it’s worth exploring what’s available from the new entrant challenger banks, as well as altfi providers such as peer-to-peer lenders, crowdfunders, the new generation of invoice financiers, and online, short-term, unsecured loan companies. With multiple products and innovative lending vehicles, and a growing number of providers with industry-specific expertise, there’s likely to be a form of borrowing in existence somewhere that will be a perfect fit with your business and its particular needs.
In essence, being thorough, prepared, and having a clear and evident understanding of your enterprise are the best way to embark upon a lending application. And, even if things don’t go your way, don’t give up. Think about challenging the decision – almost one in three SME credit decisions made by banks that went through an independent appeals process recently were overturned – and look at other lending alternatives. You may be surprised how many there are available. Good, sound enterprises should find a funding match with a lender that wants to help them invest, flourish, and grow.
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