This is a question that many small and medium size businesses (“SME’s”) raise every day. Obtaining adequate financing for SME’s is a constant source of frustration for owners and business operators.
Let’s be honest -- banks and other traditional lenders of working capital view SME’s as being of higher risk than larger and well established companies. For the most part, and particularly in Canada, SME’s are under-capitalized and have difficulty raising much needed capital when the personal resources of the owners are exhausted. This puts SME’s at a distinct disadvantage when it comes to raising day-to-day operating financing.
So, what is an entrepreneur to do when faced with growing, profitable orders, and no working capital to fill those orders? While there are “alternate lending sources” (outside the banks and traditional lenders), we will leave that discussion for another day. We will focus instead on how to approach your banker.
Let us look at the mindset of traditional lenders to SME’s.
- Most of them have a desk full of files for deals already on the books and they have a full workload already.
- They generally have a simple philosophy when it comes to who should put money into your company; “they fully expect that the shareholders/owners will have fully committed themselves financially and otherwise to the enterprise”. In other words they are not prepared to commit their depositors’ funds to an enterprise where the owners are not committing their funds first.
- Equity is equity -- it goes in first, stays there and comes out last -- after everyone is paid.
- Next, banks get in last and get out first, and while they are in they have a first security interest over everything. But do not forget, banks lend money and want money back -- not receivables or inventory --and they expect the owners, not the bank, to convert receivables and inventory into cash.
- Banks want financial information, historical, current and forecasts and they want it well prepared and an accurate reflection of the performance of the past and a realistic and achievable plan for the future. In addition they are looking for a plan for the future. There is an old adage bankers live by “companies who fail to plan, plan to fail”.
- Finally, banks want owners to know the business and to clearly demonstrate that they can meet the forecasts and targets and that they are committed, completely, to the success of the company.
So, now we understand the mindset of the lender how does the SME deal with a request to the lender?
We know the banker is looking for financial information. Not something scribbled out on a napkin but proper financial statements, prepared by and reviewed by an accountant. The statements must provide full and complete disclosure and have sufficient notes and descriptions of the information in the statements that they can be easily understood. In addition the owners, who will be visiting with the banker, must clearly understand the statements and all the information they contain and be able to explain it fully. No banker wants to hear “I really don’t understand this you will have to speak to the accountant”. The statements and the information contained therein are the responsibility of the owners.
Most prudent owners plan for the future. That plan should be detailed both in terms of the financial forecasts and in terms of a written, comprehensive business plan. Bankers love plans and forecasts if they are well prepared and presented. The business plan and forecasts clearly demonstrate that the owners know where the company is going and how the owners intend to get there.
SME’s must take advantage of their accountant and, where necessary, hire a professional consultant to help with the preparation and presentation of the financials and the plans. While this strategy will have a cost associated with it, consider it an investment rather than a sunk cost. A well-prepared and well-presented presentation goes a long way to securing the financing required.