It is not uncommon for local SMEs to find that they need to approach banks or other financial institutions to obtain finance for their trading activities. We therefore prepare this leaflet in order to provide some practical guidance to SMEs.
A Few Preliminary Hints
Talk to your banker or financial adviser before you start negotiating with your customers or suppliers. The type and terms of credit you obtain from a bank should be closely linked to the method of payment you use to settle your creditors' invoices, or that your customers or buyers use to pay you. It is important to note that your bank's motivations will not be the same as yours. As a lender your bank is interested in obtaining a good return on money lent and it does not want to run the risk of not being paid. Your bank may want to solve your problem quickly, using techniques that are best known to its staff and that involve the least effort or risk. To protect their own interest, your bank may ask for charges on your fixed and current assets as security.
On the other hand, you will want to look at all the options. You will want the bank to consider your trade transactions on their merit, be your partner and share the risks with you.
Of course, your bank is in competition with other institutions. It will want to retain you as a customer if it considers you creditworthy and a good person or company to deal with, and if you offer good growth potential.
Bank's Lending Criteria
There are no standard criteria for bank credit. Banks and other lenders tend to set their own internal rules. Nevertheless, all financial institutions are bound by general regulations and guidelines established by the regulatory body (namely, the Hong Kong Monetary Authority) or their parent companies (for overseas financial institutions in Hong Kong).
Banks may sometimes invoke their lending criteria or statutory regulations as a pretext for not granting a facility to a borrower. There is nothing much you can do about this and, in any case, it is unwise to insist on borrowing from an unwilling lender. Your request for bank credit will have greater chances of success if you can satisfy the lending criteria set out below.
- Good cash flow
As a borrower, you must show that your performance is positive and that operations are not only profitable but also generate sufficient cash to cover all commitments.
- Adequate shareholders' funds
In other words, you must not be already over-committed to other lenders, but have a reasonable proportion of your own capital in the business.
- Adequate security
You will not obtain credit form a bank if all your assets are already pledged to other lenders.
- Experience in trading
Most institutions like to know that you have a good record of successful trading. It is difficult to convince a banker to lend you money if you are a complete beginner, or if you are starting a completely new trading activity with untried products and unknown customers or suppliers in countries you have never dealt with before.
- Good reputation and standing
Your references and credentials must be acceptable to lenders. They would no doubt find it difficult to convince their loans committee or board to approve an advance to a bankrupt company or a known crook! But, even assuming that your past is without blemish, it is helpful to have the backing of a reputable sponsor. This could be a well-known person in business, your trade association or even your customer or supplier.
- Specific purpose
Although some lenders grant overdraft facilities on the basis of the security you offer, most institutions prefer to link their loans to specific transactions. Transactions must be explained in full detail and shown to be profitable and self-liquidating (money borrowed will be repaid from proceeds of transactions to be financed).
Presenting Your Request
- Know With Whom You Are Dealing
Unless you are already one of the institution's customers and know it well, find out all you can about the institution beforehand. Try to obtain a copy of the institution's annual report and review its affiliations, shareholders and directors. Brochures and annual reports, normally freely available in banks and other institutions, tell you a great deal about their structure, organization and services. Banks should also indicate their lending rates and give you a schedule of their charges and fees for services.
- Give prior notice of your intentions
Call beforehand for an appointment or, write a letter or a fax setting out briefly who you are and what you do, how much you need to borrow and why. Although you can conduct your transactions by correspondence, it is usually preferable to meet the person in charge of commercial lending or trade finance.
- Be well prepared
Your banker is a busy person and needs to know rapidly the nature of your request: you should come quickly to the point. State who you are, your line of business, how much money you need and for what you need it. Be prepared to provide your annual report (if you produce one) or your financial statements (balance sheet, profit-and-loss account, budget, business plan), as well as a company brochure. State clearly what you intend to do with the funds you want to borrow. If your intention is to finance the purchase of goods or services essential for manufacturing products for export (or the purchase of commodities from producers for export), tell your banker the whole story: from whom you are buying, to whom you are selling, how you intend to pay and get paid. Speak to your bank about these matters before you sign contracts or agreements with your suppliers and customers or make payment arrangements.
- Seek advice
Experienced bankers can guide you and advise you on risks of various payment methods, on suitable ways to finance transactions and on the security you should provide as a guarantee for your borrowings. Remember to ask about hedging possibilities to cover or reduce risks of currency and price fluctuations.
- Be cautious
Resist borrowing more than you need, for too long, or at too high an interest rate. Banks sometimes propose the types of credits or payment methods with which they are most familiar, which are most remunerative, or which present the least risk. Ask about costs. Remember there are costs, fees and charges in addition to the interest rate. What about front-end fees? (These are payments deducted from the loan at disbursement to cover the lender's cost of evaluating your request, assessing the risk or opening the loan account.) What are the back-office fees? On each disbursement, for instance? If the advance is applied by the bank to purchase foreign exchange or to open a documentary credit, how much will it cost? Most institutions have standard or sliding-scale rates for their services. Never hesitate to ask for a copy and seek guidance on how these rates will affect your transaction. If there are to be legal costs, such as lawyer's fees for drafting a loan contract or registering a charge on assets or a debenture, obtain clarification before committing yourself.
- Avoid "shopping around"
Bankers will not like the idea of your shopping around for the best deal, visiting several institutions and making comparisons. If you say you have found a better deal elsewhere after they have spent hours with you, drawn up documentation and obtained clearance from their loans committee, senior management or board, you have wasted their time. There is, in fact, nothing wrong in trying to get to know the banking sector and wanting the best deal. But you should not give the impression that you are also talking to others after negotiations have reached the stage where the agreement is virtually finalized and awaiting management or board approval. The success of a good borrower-lender relationship is built largely on trust. Trust is developed over time and is the result of positive experience. A banker will often prefer to try out a prospective customer by offering small, well-secured loans on a very short-term basis to see how it works. As transactions are successfully repeated, the customer's standing rises and his or her credit improves. When you approach an institution for the first time, bear this in mind. The cheapest lender may not, in the long run, prove the best.
What A Bank Needs To Know About You
Be as open and transparent with your bankers or financial advisers as you can. This will enable them to grasp the full situation and to give you appropriate advice. To withhold important information, such as your possible liabilities with other lenders or the fact that you have already pledged your assets, will inevitably cause difficulties at a later stage. Then you will have only wasted time and probably closed the door to future dealings with the bank.
If the lender does not already know you well, it is best to have background information ready. This may include:
- Letters of introduction
If you are not yet known in your business community, you may find it worthwhile to seek the sponsorship of someone respected by other business people who is sufficiently acquainted with you. A short letter, setting out your achievements and testifying to your good character and integrity, is a traditional method of introduction. Its effect will be positive if the referee is a person well regarded in the business community.
- Your profile
This is a resume or curriculum vitae, setting out your educational achievements, professional training, qualifications, employment record and achievements. It need not be longer than a page or two. Your profile helps your bank to assess your capacity for conducting trade, producing goods and services for export, and managing people. Attach any certificate or reference from former employers if you feel this is relevant and will help to show up your experience and capacities, especially if the employer is known and respected, and has written favourably about you.
- Brochure on your business
Do not hesitate to hand out your company brochure. This should state your type of business, your products and how long you have been trading. A list of clients or customers is helpful. If the list is confidential, say so when you give it to your banker. If you are in partnership or have directors in your company, state who they are and draw up a very brief resume on each, particularly if they have a good reputation in the business community.
- Bank and other references
If the institution is not your current bank, provide bank references that will enable the institution to check your credentials, particularly for regularity of payments, past borrowing record and general standing. The names of your accountants and lawyers may also be helpful.
- Proof of company ownership or registration
Evidence that the company in whose name you want to borrow belongs to you or has been duly registered will normally be required. You may also be required to provide a sworn list of assets and liabilities in the absence of audited or approved accounts. Try to find out beforehand whether there are eligibility criteria for which you need to produce documents or statements, particularly when approaching government or state-owned institutions providing special facilities for exporters.
- Financial situation
A lender will expect up-to-date financial information on your business. The standard financial reports you should have ready are:
- Balance sheet, profit-and-loss account, and cash-flow statement
These should have been audited by a firm of chartered accountants, or certified by an independent accountant and approved by a resolution of your board of directors. Otherwise, you may have to produce evidence that your accounts are a true and fair reflection of your financial situation. The size of your balance sheet and the amount of equity in your business are significant, but by on means the determining factors in your banker's decision to grant you short-term credit. Your banker may be far more concerned with the transactions that the facility will finance. If your audited accounts are more than, say, three months old (that is, if the closing date of the accounts goes back three months or more), you should also have with you a recent operating statement and cashflow statement.
- Budget for the current or coming year
This document should show your projected sales and revenues for the current period or the coming year, as well as your operating costs and overheads. You should also have a separate paper showing your planned capital expenditure, if any. Your budgeted (or estimated) revenue should be sufficiently detailed to be credible. In other words, the figures must not simply be wishful thinking but based on firm and tentative orders to which you may add orders anticipated on the basis of past performance.
- Details of order(s) booked
If you are requesting credit to fulfil a large or profitable new contract, have all documents, correspondence, quotations from suppliers, draft contracts with buyers and suppliers, and your own costings and calculations ready for discussion. This is all the more important if your order is for export. The credit facility you obtain from your bank will almost certainly need to tie in with the payment methods that you use with your suppliers or that are stipulated by your overseas buyers. Do not sign any firm contract with suppliers or customers before you have discussed credit and payment methods with your bank. The reason is simple. Most import-export business agreements or contracts stipulate the form of payment and the credit (delayed payment) terms the buyer or the seller offer or require. Once the contract is signed, it may be too late to alter the terms and this may seriously limit the scope of the facilities your banker may be able to offer you.
- Business plan
An up-to-date business plan for your company, showing intended capital investments and forecast revenue and expenditure for the coming three to five years, is an excellent document to produce during discussions with your banker or financial adviser. If you do not have such a plan, you may find it useful to draw one up. It will be of great value to you personally, and will add to your credibility when you discuss your credit request with lenders.
- Feasibility study
Feasibility studies are usually carried out in connection with medium- or long-term projects and are consequently prepared, among other reasons, as an aid to raising medium- to long-term project loan finance. You may wish to start a new project or expand an existing activity, and needed capital to finance the additional capital goods required (e.g., machinery, tooling, spares and raw materials). You will need a feasibility study to present to your banker. You will also need to give copies of draft or actual loan agreements with other lending institutions. These are important because the loan agreements may stipulate that you cannot borrow from another lender unless the loan is subordinated to them. This may mean that you cannot pledge fixed or current assets if the first lenders have fixed and floating charges on such assets. You may be limited to providing your bank with a second charge or some other, less secure, form of guarantee. In many respects, the feasibility study is not dissimilar in its presentation to the business plan. The main difference lies in its purpose.
Guarantees Or Collateral You Can Offer
Not many lenders will grant you a loan without security. What guarantees or collateral can you offer? The terms security and collateral mean the same thing: guarantees you give lenders by pledging assets which they can seize and sell off if you do not pay back the loan. Other forms of guarantees are an insurance policy to the benefit of the lender, or an undertaking by a third party to repay the loan, should you default. You can even obtain a guarantee from one bank to borrow from another. This is current practice if you borrow from a bank overseas. The guarantee is given to the foreign bank by a local bank that can more easily take a charge on your assets than the foreign bank.
The most common form of security is a charge (pledge) on fixed assets, particularly land and property. Most lenders feel that land and property are readily marketable, even if sold at a price below market value. Moreover, land and property are evidenced by title deeds and, in many countries, these titles are registered by the authorities and any encumbrance would also be noted. (When an asset is encumbered, another party has a valid claim on it.) When an asset is pledged to a lender, it is encumbered and it cannot be pledged a second time to another party unless the two parties agree to share the security.
Other fixed assets can also serve as security (machinery, equipment, vehicles, etc.). It is often impractical for a lender to consider these as security because their market value is often difficult to determine, especially if they are not new.
Investments are sometimes acceptable, particularly if they can be easily realized (sold). These are evidenced by share certificates of companies listed on the stock exchange, bonds, debentures, treasury bills, etc.
You can pledge current assets: stocks of raw materials, finished goods, commodities for export, even receivables. The easiest net asset to pledge is cash. This is called cash collateral. Your loan is secured by money! Borrowers resort to this form of security when they have liquidity in another bank which they do not want to touch. (It may be in another currency, tied up in investments, funds owned by a third party, or funds owned by the borrower, but not part of his or her business.) Have a list of assets that you are prepared to pledge as security for the loan. For land or other property titles, bring copies to show the bank.
Financial institutions rarely lend the full value of the security taken. The reason is plain enough: should they sell the security because of a payment default, the price they obtain may be less than the value of the loan. The amount of cover needed for loans varies from country to country and asset to asset. In some cases, you may have to pledge assets worth two or more times the amount of the loan.