Mz Moneypenny

When applying for credit, remember that you must have a credit history – either in the name of your business or in your personal capacity. If you have previously shunned formal credit facilities, consider applying for a business overdraft or business credit card. You can then start paying back the credit facility in order to establish a good track record for repayments.

Only spend as much as you can pay back and always pay by the due date, which will show that you are capable of handling debt and take the responsibility of repayments seriously. If you can’t make a payment by the due date, it’s best to speak to your bank and make arrangements rather than ignore the amount due. Most creditors would settle for a small payment rather than no payment at all.

If you are declined credit, find out why. There are various reasons why a credit application could be rejected, some of which are fairly simple to rectify. With negotiation, a smaller credit facility could be approved.  On a more serious note, you may have been declined for credit because your business, or you, or a business partner, is black-listed. If this is the case, you need to try and get the credit record cleared, or you will face problems in obtaining credit anywhere (including terms from suppliers).

The website of The National Credit Regulator provides information on how to check your credit record and it is a good habit to check it every 6 months in case there are any problems or inaccuracies.

There are different forms of funding available to small businesses. These can be placed into four broad categories:

• Private loans
• Bank finance
• Asset finance
• Private equity investment

Private loans consist of seed capital, bootstrap funds and angel investments. Often raised from the entrepreneur’s own savings, and sourced through family and friends, private loans tend to have no set repayment structure. They are the most common form of start-up finance around the world, and sometimes a small business may not need any other formal credit facility. However, these types of loans may be the cause of rifts in the family and friendship if there are unrealistic expectations. For example, the entrepreneur may think that the loan does not need to be repaid quickly, but the friend expects fast settlement and may even charge interest at rates higher than from a financial institution. It’s best to set out a formal repayment arrangement with the private lender, to keep things on a professional basis and protect the interests of family and friendships.

Bank finance takes on different forms, the most common being overdrafts, credit cards, and term loans. Smaller overdraft and credit card facilities are typically offered on an unsecured basis to businesses with a good credit history. These types of short-term credit facilities rely heavily on the ability of the business to repay the debt, so keeping good records of your cash flow is important to having these facilities approved. If the business is unable to settle the debt on time, the owner will be called upon to do so, and that’s why the bank will ask for a letter of suretyship from the owner. Sole proprietors are not required to sign a letter of suretyship, as the business and the owner are regarded as being inseparable.  In some instances, the same principle applies to single-member close corporations. However, all other forms of business entity are required to furnish letters of suretyship from their owners as a pre-requisite to obtaining the credit line.

Unsecured facilities tend to be offered at a relatively high interest rate. If you have collateral to offer against the facility, you can negotiate a lower interest rate with the bank. Collateral taken into consideration is usually outside of the business, such as a second bond over property, cession of the surrender values of life insurance policies, pledging of investment accounts or share portfolios. In rare cases, the bank will consider taking a notarial bond over business assets, or cession of the debtor’s book.

Overdraft facilities are “callable”, that is, the bank can ask for full and immediate settlement of the facility at any time should the business circumstances deteriorate and the bank believes that it may not recover the funds at a future date. Interest is paid on the amount of the facility utilized (calculated on a daily balance), and there is an annual Facility Fee payable. The advantage of an overdraft facility is that it is a form of cashflow insurance, meaning that it is there to be used when your debtor’s receipts don’t match your creditor payment cycle and you find yourself short of funds for a few days or weeks. This is “working capital” facility designed so that your business can continue operating while you wait for your invoices to be settled.

Credit card facilities are generally of the “charge” variety, meaning that the full balance owing must be settled within a certain time period. Purchases are interest-free for that time period, so effectively it is a short-term interest-free loan, provided that the full amount is paid on the due date. Failure to settle leads to interest being charged from Day 1, plus penalty fees being levied and your credit record being adversely affected. Cash advances are subject to interest being charged from the date of the advance, as with an overdraft. Credit cards are convenient for day-to-day purchases and online transactions, and the credit facility is separate from your transacting account.

Term loans, or Business Loans, are distinguished from personal loans in that they are taken out in the name of the operating entity and are generally secured by the owner’s assets, such as property, investments and life insurance policies. This is because the loan is a contract between the business and the bank, with scheduled repayments taking place over a longer period. Depending on the risk profile of the business, the bank may be comfortable with assuming some exposure to the business and may not ask for the loan to be fully secured. Business loans have a term of up to 60 months, and generally have lower interest rates than an overdraft or credit card because they are secured.

A revolving loan allows the business to redraw on capital amounts that have been repaid. FNB’s Flexi Loan requires that 15% of the loan amount be repaid before it may be redrawn. The loan repayment amount stays the same, but the term of the loan is extended by a few months. This enables the business owner to budget for steady monthly repayments, and gives easy access to additional credit should the business require a little extra funding.

FNB has a longer term loan, the Business Bond, which provides financing for businesses for up to 120 months. This loan is secured by a covering bond over residential property, and is a means for the entrepreneur to release the equity value of the property and use it to finance the business.

Entrepreneurs who struggle to get bank loans because they lack collateral can apply for government-backed loans. The Small Enterprise Finance Agency (Sefa) is a new state agency that was launched on Monday 23 April 2012. It is a result of a merger between Khula, the SA Micro Finance Apex Fund (Samaf) and the Industrial Development Corporation’s small business lending portfolio, and is a wholly-owned agency of the IDC. Sefa will have access to R1.4-billion in funding for South African small businesses over the next three years. The (IDC) had pledged R921-million to Sefa over the next three years, while the government has put in R535-million. It will focus on providing loans of up to R3-million to small businesses.

Samaf and Khula had previously lent out through banks and financial intermediaries which would then on-lend to small businesses. Sefa would continue to use these two channels, but would add a third channel – that of direct lending to SMEs, which is currently being piloted. The new agency would partner with the Postbank and the commercial banks. Sefa’s products include bridging finance, revolving loans, asset finance, working capital and term loans. The agency will also provide microfinance of up to R100 000 to micro enterprises.

Asset finance takes the form of instalment sales agreements, also known as hire-purchase arrangements or leasing agreements. In this case, the asset itself provides the collateral for the loan, and the business takes ownership of the asset once the loan has been repaid in full.  Instalment loans are paid back with equal monthly payments covering both principal and interest. Instalment loans may be written to meet all types of business needs. You receive the full amount when the contract is signed, and interest is calculated from that date to the final day of the loan.  Sometimes instalment loans can be structured with a balloon repayment of 30-100% of the capital repaid at maturity. These loans require that interest be serviced over the loan period, with a final balloon payment at the end. This type of payment structure is often used to finance vehicles, where the balloon payment is equivalent to the residual value of the vehicle at the end of the financing period.

Debtor Finance is useful for businesses that are growing at a rapid pace, and which need to raise money against invoices in order to pay suppliers. The major advantage is that the business does not have to wait for client payments before getting hold of cash to be used to operate the business. If your business cannot afford to carry debtors for 60-90 days, then debtor finance may be an option. The bank may offer collection services in addition to marking a facility against the debtors’ book. For this kind of facility, the business owner may not be required to put up additional collateral. Freeing up cash tied in the debtors book may allow the business to negotiate discounts with suppliers, offsetting the cost of factoring.

Private equity investments are long-term and involve trading a share in the business for funding. The investor pays a great deal of attention to the entrepreneurs and assesses the viability of the business before making a commitment to fund. Small businesses with great growth potential and above average profitability that are run by experienced and knowledgeable owners may find that they are able to raise significant amounts of capital in this way. The investor will be hands-on and involved in the decision-making process of the business, as they have a vested interest in ensuring the success of the venture.

Access to credit, new markets, skill acquisition, and production technology are common needs identified by growing SMEs. Roughly two-thirds of South African businesses fail within the first two years – according to Adcorp research, some 440 000 small businesses have failed over a recent 5 year period. This high rate of failure has been attributed to three primary factors:

1. Lack of financial record-keeping,
2. Heavy administrative and regulatory burdens, and
3. Inadequate funding.

Local banks have been at the forefront of assisting business owners with the tools to make keeping accurate financial records less of a chore. Understanding that small businesses may not have the resources to employ a book-keeper or accountant, FNB offers Instant Accounting, which is an online service that interacts with both the transactional account and the credit cards of the business. It enables the business owner to produce management accounts and budgets, without needing to employ or retain an additional administrator in the business. Included in Standard Bank’s BizLaunch offering is access to Pastel accounting, which allows the entrepreneur to keep track of sales, purchases, inventory, customers, suppliers and cash movements.

While banks have no impact on reducing administrative and regulatory burdens imposed on SMEs by the State, they are able to assist with funding. Access to capital and credit is essential to the development and expansion of small businesses, but many entrepreneurs believe that it is difficult to obtain finance for their businesses.

Debt funding should be used to finance things that are going to make your business better, not for “nice to have” accessories. The money borrowed should have a definite application, something that is either going to save or make money. This could be starting a new business, expanding your current business, buying equipment to increase your production capacity, taking on a government contract, funding the purchase of another business, or planning a management buy-in or buy-out.

The next blog will consider different forms of credit funding for small businesses.