Applying for business finance – what you need to know
In the current environment, raising business finance can be a real challenge. In the age of online information, being prepared is everything.
There are many different lenders out there and underwriting style varies widely. At one end of the spectrum, some lenders use algorithms. At the other end, others still rely on good old fashioned ‘meet the customer’ and build something to fit. Depending on the situation, both approaches work depending on what the need is. Just to be clear, this isn’t covering either invoice finance, property finance or asset finance!
What will you need to provide?
Let’s look at the information a business will be asked to provide to apply for finance. You could be asked for information that is not on this list.
- Last year end accounts (maybe going back 2 years)
- Latest management accounts
- Last 6 months bank statements (usually an electronic version is requested which can be downloaded from your bank’s website)
- Last 5 VAT returns
- Full details of the directors – full names, dates of birth, addresses, contact details, identification to complete money laundering requirements.
- A summary of the existing finance in the business, security given and repayment terms
- Details of fixed assets owned by the business
- Up to date Sales and purchase ledgers
- Assets and liabilities statement for each director/shareholder
- Forecasts covering the next 12 months
- There isn’t usually a need for a long drawn out business plan with lots of narrative. It may be required in due course but not an essential start point. Most lenders will require some commentary on salient points that can be identified through the application process.
- If a property is being provided as security, some understanding of the market value is always helpful. It doesn’t need to be a professional valuation (the lender will often commission their own at your expense). However, having a chat with a local valuer to get an understanding of the ball park numbers is always helpful.
Review public information
There is also some key information to review before starting to apply for business finance
- Do public records accurately reflect the current state of the business. Check Companies House to ensure that shareholders/directors of the business are up to date. If they aren’t, file a confirmation statement
- Does the company credit rating reflect the actual performance of the business? Bear in mind that if the business is under the audit threshold, very limited information will be registered with the rating agencies and there is good evidence that it is not correct.
Where to go for business finance
There are many options. Some of them are listed below…..
- Speak to your bank. Assuming you have a relationship with your bank, this is always the best place to start. They should know your business (although you will be surprised how little a long-term relationship counts for).
- Talk to your advisors – many businesses will speak with their accountant to get their input. This is a good idea providing your accountant has the contacts within his network who knows what is available in the marketplace.
- Ask a finance broker to help you find financing. There are many skilled brokers who have a good understanding of the marketplace. Some are ‘general practitioners’ and others will be niche market. Check what the broker can do. They may refer you to another specialist that they know and have worked with before.
- Turn to the internet. Google is both your friend and foe here. Type the word ‘finance’ into a search engine and there will be pages and pages of answers. Many companies pay to promote this word and other similar terms. Just because they are at the top of the list or on page 1 does not mean they are the best. Bear in mind that many of those featuring will be brokers not lenders, although websites do not disclose that. Remember the old saying – if it looks too good to be true, it probably is.
Secondly you could
- See what other businesses have done. We all operate in a space where we know other business owners and can seek their input based on their own experiences. This can be very helpful, depending on what your network has done in the past.
- Do It Yourself – it is possible to find the funding yourself but this will take many hours of your time. Just because your mate down the pub says it is possible does not mean it is. Getting professional advice and input is key to success here.
There are many adviser/brokers/finance finders out there – some good, some bad, some indifferent. The key here is to find someone who is either recommended and/or has experience of the marketplace. Track record, longevity and success are hallmarks of success.
A well-established adviser who has been in the industry for a number of years and has weathered a few storms is far better than a recent entrant with limited experience, hasn’t worked for lender and has limited track record. The website might look nice, but that doesn’t get a deal done.
A good adviser will review your business finance proposal. He will also verify and assess the information you provide (see above), refine as necessary and then look at the options. This ensures a targeted approach to lenders who are likely to be interested in providing funding. In some cases, that may only be one lender.
One thing to avoid here is speaking to multiple advisers and getting them all to work with the same information. A deal that does the rounds rarely gets done. Especially when the deal is seen by multiple lenders in a short space of time. Some applications will generate a soft search on the company credit file and this also acts as a warning sign.
Process for applying for buisness finance
This depends on what is being requested. Some common scenarios are set out below.
Short term cashflow funding –
these are often algorithm-based lenders who check a number of data points including credit rating, bank account conduct, company and personal search on the directors. If all the checks come back within the set criteria, this can be approved very quickly (within 24 hours), an offer issued and legals completed electronically for funds to be drawn down within a matter of days.
Terms loans –
to support business expansion and growth – this requires more in-depth analysis of the past, present and future financial performance of the business. Expect a lender to review the high-level numbers and provide some form of indicative terms for review before then progressing to more detailed due diligence. Ask for a timescale, lenders can be notorious for moving very slowly when the need for funds might be quite quick. Banks are very good at giving the impression they are working on the proposal when in fact nothing is happening.
Further information may be requested to support the application for funding which will be submitted to credit committee for approval. It is rare that you will deal directly with the underwriter, although in some cases this may happen (and can make the process easier).
Funding involving property –
providing the right information at the start should give the lender enough information to issue a decision in principle. Again, this can be reviewed, and terms discussed before embarking on the next round of due diligence – this will usually involve a valuation (usually at the borrowers cost, expect to pay for this at the time it is done).
Once the valuation is complete, credit approval can usually be obtained, and lawyers then instructed. Some people see this as getting near completion, but this is where the hard work can start with the involvement of various lawyers at your cost. Be aware that the lenders lawyers have to sign everything off before funds are released and the volume of searches, paperwork and title documents can be significant. Having these in order at the start of the process and working with an experienced lawyer can be very helpful in getting access to funds in a timely manner.
Security required to apply for business finance
Gone are the days where the bank would lend you money on an unsecured basis because you were a good chap or you were the bank manager’s friend. There may be some rare situations where this is the casebut for the most partlenders will require security.
What does this entail?
Depending on the facility being sought, the following may feature.
- Debenture on company assets (also known as a fixed and floating charge)
- Mortgage (usually in relation to a property)
- 2nd mortgage (where there is equity in a property)
- Chattels mortgage – this will be against a particular asset
- Sale and leaseback – where finance is being raised against certain assets, they are being sold to the lender and they are leasing them back to the company for a regular payment.
- Personal guarantee – where key individuals (usually directors) are being asked to guarantee a certain amount. Always check the limit of your liability in this instance. See the section about this below.
- Intercompany guarantee – if there are associated businesses under the same or similar ownership, these are providing comfort to the lender.
- Charge over credit balances – rare these days but still a possibility
- Charge over shares – this provides some control to the lender – usually seen where a business is being acquired.
Personal Guarantees when applying for finance
It is pertinent to talk about personal guarantees as they are common in the current marketplace and will become more so in a poor economic environment. Depending on the funding required, lenders may ask for personal guarantees. It is highly likely that a personal guarantee will be sought if no company security is being taken . As part of the application process, most lenders will want to know if directors are homeowners.
Before starting the process, decide what your position is on giving personal guarantees. Some lenders will look more favourably on proposals where guarantees are offered, for others it is a requirement and for some lenders it doesn’t feature. It does depend what other security is being offered.
Terminology is also important here. An unsupported guarantee does not require a charge being given on property. A supported personal guarantee will require a charge on property (either your main house or other property). In the case of a supported personal guarantee, it will be required that Independent Legal Advice (ILA) is given to all owners of the property – this may include significant others who have no involvement in the business.
It is possible to take insurance out on a personal guarantee – it isn’t a cover all and there will be exclusions so read the wording carefully if this is a route you choose to go down.
One point to note
If you make it clear that you don’t want to provide a personal guarantee, some lenders take this as a warning sign that there is an issue with the business. Lenders have a view that if the director isn’t prepared to commit their own support to the business, then why should they?
Every loan facility comes at a price – usually the key aspect here is the interest rate but it is also worth considering additional fees that may appear at the start and end of the agreement.
The interest rate for business finance will usually reflect the risk that the lender perceives, so the higher the rate, the higher the risk. Many things feature in the calculation of the interest rate, credit rating is a key part, and this is why it is important to ensure the company credit rating is as high as it can be. The cost of achieving a high credit rating can be more than offset by the benefit of a reduced interest rate. Remember that unless it is a high street bank, every funder is having to buy money in before lending it out, so the cost of funds (anywhere between 5 and 10%) will be priced into the transaction
Ask the following questions…..
- What is the interest rate for the loan
- How is it calculated
- When is it charged
- Is there a reduction for early repayment
When it comes to fees, there will usually be fees to pay at the start of the facility and sometimes at the end. Ask for a full list of the fees payable so that you enter into the agreement knowing what it costs to exit. Some lenders aren’t so forthcoming around the full list of fees. Be wary of signing any legal documents if you do not understand/have not had the fee structure explained.
About 30 years ago, raising equity was not too difficult for an SME. The marketplace has changed significantly and there is no longer a swathe of equity providers looking to get involved with SME’s, largely because they are difficult to underwrite and the level of return isn’t attractive.
3i no longer exists (one of the main equity providers to SME’s) and whilst there are various boutiques that will look at equity investments, they are very selective and will only want to look at high value high growth businesses, usually in specific sectors.
There are various equity initiatives around with British Business Bank funding – be aware that these are never quick and will come at a price driven by an exit value. Directors powers to agree remuneration etc will be capped and there is a view that you spend most of the time working for the equity provider who will be driving growth and build value for an exit.
Very few debt providers to SME’s look to take equity. There are not many equity providers who look for a steady SME business to invest in. However, some business angels around who will take a stake, but make sure it is a good fit. Undoing it can be messy.
Sources of funding for business finance
High Street Banks
High Street Banks are still the largest funders to UK SME’s by some distance. In terms of pricing they are usually the cheapest as their cost of funds is low (think about the interest paid to savers).
Non-bank funding (ie everyone else) is a wide and varied marketplace. Let’s break these down into different sectors (although lines are blurred in some cases).
Internet based short term lenders
Internet based short term lenders – rely upon an algorithm for credit assessment – will be quick turnaround and will usually require a personal guarantee – max £250k, longest repayment term of 3 years and usually a double-digit interest rate. A quick fix as they can be a quick source of funds but expensive in the long term. These funders do allow early repayment and can be a quick source of cash in case of need, but don’t plan to borrow long term from this source.
Peer to peer (P2P) lenders
Peer to peer (P2P) lenders – there are very few left – Funding Circle is by far the biggest player, a number of others have moved to be institutionally backed lenders. It all looks great – investors helping borrowers out and earning a good return. If you fit the algorithm with Funding Circle then its reasonably cheap money – make sure your house is in order before you apply and credit rating will be crucial for pricing. Systems are slick and turnaround of funds is fast. Funding Circle loans do not require security other than a personal guarantee for the full amount of the loan. There aren’t many other peer to peer lenders who will still deal with SME’s.
Institutional funders – some of the P2P lenders have morphed into institutional lenders as all their funding comes from one or two sources. Generally looking for deals over £500k (and some £1 million) – they are good at providing cashflow lending to growing businesses. Acquisition finance to support an MBO or MBI is a strong point and will lend on criteria based on cashflow and profit rather than asset value. Due diligence will be quite in depth and lenders will be looking for a strong profitable cash generative business which meets the required debt servicing metrics.
Alternative finance providers
Alternative finance providers – there are numerous alternative finance providers in the UK. Some are privately funded, others have finance provided by the British Business Bank or European Investment Bank and are targeted to lend money to specific sectors or geographical locations. BBB and EIB back funds are usually looking for a social impact angle and will also have a high level of due diligence – this money normally comes with strings attached. Bear in mind that these are not grants so serviceability is key – the lender will want to see a business capable of making a profit and not a business that is losing money on an ongoing basis.
Traditionally the preserve of the clearing banks, there are now many property funders in. the marketplace. Currently, the High Street banks are the prime lenders, offering funds at low rates for a fixed term – anything up to 10 years.
The key aspect of any property proposal is knowing the realistic value of the property (sometimes described as the 180 day valuation), having sufficient cash to meet the shortfall between loan and purchase price and good repayment capability.
However, bank’s credit policies have a high threshold. Loan to value will need to be 70% or less to get prime rate and debt service requirements. That is Income/profitability to repayment ratio will need to be good. Banks are keen to lend with property as security. However, it will not be particularly quick and the security will take some time to put in place.
The secondary marketplace has a number of lenders who have lower credit thresholds. They can move more quickly but have higher interest rates. Appetite is stronger in this marketplace.
The bridging marketplace is full of lenders who can move quickly. Pricing is much higher. It is also usual that it will be an interest only facility with an exit within 12 months.
Prime lenders are keen to support good businesses with the purchase of new capital assets. Numerous formats are available which can either treat the asset being purchased as a capital item (asset finance) or as an expense (operating lease). A profitable business acquiring new assets with a reasonable deposit should be able to get asset finance as low rates.
Refinancing existing assets is the preserve of secondary lenders. The value of the assets being refinanced is the key issue. They are usually lower than expected and may require an independent valuation depending on the nature of the assets. Interest rates will be higher (double digit interest rate) and personal guarantees may be required.
Richard Mason of Ludgate Finance wrote this article. Richard explains, “following a move to an advisory role in 2007, it became clear that SME’s were struggling to be serviced by the banks. Alternative finance sources were required. With the advent of peer to peer lending, I sourced and completed over 200 deals. I raised in excess of £30 million to support SME’s in their growth and acquisition ambitions.”