How To Get A Business Bank Loan. Tell Your Bank What It Wants To Hear.
This is video 8 of the MasterClass for corporate advisers and entrepreneurs on “Persuasive and Effective Business Plans” in which I’m going to discuss how to adapt your core business plan in order to raise bank finance. To borrow money from a bank, your business plan should include the narrative, data and statistics required for raising equity capital – which I’ve discussed in my previous videos. Although I’ve previously emphasised that a business plan for an external audience should be short, relevant and precise, the one exception is when you adapt your core business plan with a view to arranging a loan from a commercial bank. Despite their extensive advertising to the contrary, commercial banks no longer employ many experienced staff who understand small- to medium-sized companies – SMEs. If a few such staff still exist, they no longer have the authority to make a decision on their own. Most of these self-styled bankers are merely clerical box tickers who rely on impersonal credit committees to think for them. The thing to remember, however, is that the foundation of a successful commercial banker’s career rests on the continued avoidance of mistakes. At the very least, therefore, such banking box tickers will want to feel comfortable that, should a loan to one of their customers turn into a bad debt, the blame will be thinly spread over a collective decision-making process which had access to a large amount of information in a written report. They will therefore be more likely to pass your request for a loan to their credit committee if it’s accompanied by a super-sized business plan which answers numerous questions which they themselves would probably not have thought of. Much of this won’t be relevant to a request for a bank loan – because all a bank really needs to know is that your company has credible cash flow projections (plus a margin), that is: it has the capacity to pay down the loan, with interest on the due dates – with a sufficient safety margin to allow for occasional timing differences in cash receipts. The bank will look to your cash flows as a primary source of repayment although its loan will also be fully covered by personal and, perhaps, third party guarantees – and by taking security over your company’s assets – with fixed floating charges and other protective bells and whistles. Consequently, if a bank has a responsible lending policy, it will get repaid – eventually. Therefore, what a bank is really trying to avoid is lending to companies that might get into difficulties – and therefore waste a lot of the bank’s time in sorting out the resulting mess – and enforcing its security to get its money back. The 80/20 rule applies to banking as well in that bankers spend 80% of their time on 20% of their loan book. An extensive business plan will therefore be helpful evidence that everyone concerned thought of everything before making the loan – and if it turns out badly, no one is to blame – rather on the principle that a thousand lemmings can’t be wrong. It’s also helpful to understand that bankers are used to losing money. It’s part of a territory. And if a loan officer has never had a bad debt, he or she will be criticised by their superiors for being ‘overcautious’ because they won’t be considered to be ‘close enough to the market’ and will therefore be losing business to other banks. I was once a commercial banker – for only one year – when the bank I was working for considered that it was a sensible business model to allow corporate financiers – like me – to lend money to our clients – in addition to advising them on the development of their business and investing in their equity. In that short period, before the policy was rapidly reversed, one of my loans to a client was written off completely. A total loss of 5 million pounds. It wasn’t really my fault because it was later discovered by our risk manager – who insisted on liquidating the company – that the Finance Director was having an affair with a Sales Director. As he was a very unappealing individual and
she was a very attractive girl, to keep us to keep the affair going, he was
turning a blind eye to her increasingly fictitious sales figures.
So that she earned ever higher commissions with a resulting shortfall in
the cash flow required to cover our interest in loan repayments. However, I signed the document
so the buck stopped me. Quite correctly. Consequently, when I was at the bank’s next internal drinks party, I was a bit nervous when the head of corporate banking, a very tall man, waved to me across a very large room and walked meaningfully towards me through the crowd which parted like the Red Sea. However, I needn’t have worried because, when he arrived, he put his arm around my shoulder and said: “Roger, you know – none of us are really proper bankers ’til we’ve lost our first five million” – which I thought was a rather robust, and also extremely fortunate, attitude. But it sums up the general banker’s attitude that if you stay close to the market – you win some, you lose some. Therefore, although things have changed quite a bit since the banking crisis, when you write a business plan for a bank, you should go into more detail, than is strictly relevant. So that a very full picture is given on how your company operates. This isn’t necessary for other potential investors. Because, if your business plan has persuaded them that it’s worthwhile to meet you, they’ll ask a lot of supplementary questions at the first meeting or at the next meeting. Whereas, if your business plan isn’t short and succinct, they might not bother to read it in the first place. However, you’ll always get a meeting with your bank – even if they don’t want to lend you any money. Because they’ll be hoping to sell you their other services – such as life assurance or advice on inheritance tax. You should always express immense interest in these additional services – even if you have no intention of using them at all. Because the loan officer will note that you’re a potential source of extra business. So, if he considers your loan proposal to be slightly marginal, the extra potential fees could tip the balance. Apart from ticking all their boxes therefore, your business plan should contain a very full explanation of how the company operates and how and when you intend to repay the loan. So that the banker can feel confident that, in the case of a subsequent bad debt, it’ll be easier to demonstrate to superiors that no stone was left unturned – when investigating the nature of your company. Your business plan should also be very clear on to how much you want to borrow – and why. It’s not a good response, as I sometimes receive from very small companies, to ask: “How much can I have?” or “As much as possible please”. You need to be very precise. There are only three things you can do with a bank loan – which are to buy assets, repay existing debt or finance current operations. A banker wants to be able to put together a suitable package without risk. So, if you want alone to increase your working capital, your cash flow forecasts should clearly show that the loan will be used for working capital. And will be repaid out of the net cash proceeds of your operations over one trading period – usually one year. Consequently, the bank will want to see that your forecast overdraft requirement will fluctuate in line with the nature of your business. And won’t all be drawn down at once and then bump along thereafter just above and below the top limit – effectively as hardcore debt. If you want a five year loan for expansion capital, for example, perhaps to buy some factory machinery, You should illustrate that you’ll be able to repay the loan from the sale of the additional widgets manufactured by such machinery. It doesn’t really matter if this doesn’t happen in quite the manner initially envisaged. Because business plans change. And you may wish to repay the loan early. Extend it. Or increase it – which will be another decision for the bank on another day. Bankers will also want confirmation that you’re asking for enough money to finance the strategy set out in your business plan. They won’t want to lend too little – as a subsequent funding shortfall, resulting in the failure of your business, is just as bad as lending you too much – if the loan subsequently turns out to have been insufficiently secured. Bankers will also decide whether or not they would wish to increase their lending to your company to provide more working capital – if the trading results come in lower than you expect. Or, you may want to speed up your expansion plans. What’s important, however, is that the numbers stack up on day one. In this respect, If you consider the bank may find your company deficient in some respect, explanations for such deficiencies require meticulous preparation in order to convince the banker that a loan can be safely made. The probability of receiving loan approval that will therefore increase if the risk perceived by the bank is decreased. Commercial bankers have treated smaller companies so badly in recent years that you shouldn’t consider that you owe your bank any loyalty or duty of care at all. You should assume that, for all the politeness and general friendliness between you and your bank during meetings and telephone calls, the money they provide is just like the electricity or the gas that you receive from the utility companies you deal with. It’s just a commodity that they want to sell and you want to use. You don’t expect to have a relationship with an electricity company. So, if you approach a bank with that mindset, you won’t be disappointed. Your objective is solely to produce a document that results in your receiving a loan. In preparation for a first meeting, therefore, and to lower the bank’s perception of risk, all likely questions should be anticipated and full and unequivocal explanations and answers should be prepared – and confidently explained. In assessing a loan application, a commercial banker will evaluate the character, capacity, collateral and credibility of the applicant – and consider the purpose for which the loan is to be used, the form the loan is going to take, the adequacy or otherwise of the amount requested and the proposed method of repayment. Your business plan should seek to give comfort on each of these topics. Consequently, although you may be a very successful entrepreneur, if you have any doubts surrounding your capacity to respond fully to financial questions, it’s a good idea to take your accountant to
the meeting to help fill in the gaps. Nonetheless, you should run the meeting yourself with your banker as confidently as you would run your own company.