As a banker and SME advocate, I am always asked how to secure bank credit. For an entrepreneur, bank loans represent a versatile source of financing for the business. It can be short-term or long-term, fixed or variable, demand or fixed-term, guaranteed or unsecured. It can be adapted to your needs. Obtaining it, however, poses a major challenge.
Banks are conservative because profit margins, especially in the current low interest rate regime, are limited. Traditionally, banks derive their funds from their depositors and the rate of lending to borrowers represents a mark-up or allocation over its cost. Of course, pricing is more complex these days, as banks aim to achieve a risk-adjusted return on their invested capital. Ultimately, one or two bad loans can wipe out revenue from a loan portfolio. Naturally, small business loans tend to be rationed.
However, it is possible to obtain bank financing with a little effort and diligence on the part of the entrepreneur. The starting point is to develop a financial footprint and establish a relationship with a bank, particularly with the branch manager and relationship manager. The entrepreneur must lay the groundwork.
Small businesses that are ultimately successful will go through a life cycle. Typical stages in the life of a business will go through start-up, introduction, mezzanine, consolidation, growth and maturity. At the start-up stage, bank loans cannot be expected to finance operating losses, research and development, marketing campaigns, etc. These are usually met with equity funding or the so-called 3 Fs: family, friends and fools. The third F can represent venture capital funding, if available. Unfortunately, it is lacking in the Philippines.
The reality is that until the business stabilizes, the banker probably won’t lend a lot of money. But the savvy entrepreneur must start cultivating a banking relationship early, before the real need arises. You have to build trust. Open a checking account and other accounts and use all available banking services for payments. Your business transactions must go through these accounts and this will strengthen your financial footprint. The idea is to develop a balance sheet, to stimulate interest and attention.
Once the business starts to gain traction, you can start exploring more formal funding. This usually becomes available during the mezzanine phase. At this point, you should have demonstrated proof of concept for your business to developing and potential customers. Your production or service delivery system should have overcome the initial pains of childbirth. Your attempts to sow the seed may bear their first fruits.
Remember, however, that your first trip should have considered bank compatibility. What is their attitude towards the type of business you are building? What is the bank’s risk appetite, particularly for the industrial segment and the size you represent? Not all banks are equal.
You must understand the language of bankers. They are usually credit trained and one of them is likely to be screened against the five Cs of credit analysis – character, capacity, capital, condition and collateral. Study how these are analyzed and make sure you can pass the exam in that sense. Banks will have different assessment approaches or processes because they have different risk cultures. But the fundamentals should be the same.
When considering a potential banking partner, do not rely solely on the content of advertising and other statements from the bank itself. Talk to as many resources as possible — business people, accountants, industry associations, local support units. Often it helps if you are referred to the banker by a common third party. They say that in our country there is a 6and C credit — connection.
Assuming you now think you are ready, get ready for the loan application process. Secure the typical application form and fill it well. Bankers are aware of the problem of information asymmetry and will subject you to their regular know-your-customer or KYC process and due diligence. It is important not to hide critical information that is detectable.
While completing the application form, analyze yourself from the lender’s point of view. Are the 5 Cs correctly respected? Your formal request should be well worded to address the purpose of the loan, how it will be repaid, contingencies, your business perspective, and other key information.
Remember, the goal is not just to gain your banker’s trust, but to help them build a case for you within the bank. The approval process goes beyond your contact, and your relationship manager should be your ally. Give your contact information that will help you build your case.
Once you have submitted your application, the bank will follow its internal process. Your hope is that this will result in your banker coming back to you with a proposed term sheet outlining the terms and conditions of the loan. It’s an offer, but remember it leaves some room for negotiation. Understand what is important to you and your banker. And always have a long-term view, especially if you think this is the start of a potentially win-win relationship that will help propel your business forward.
Benel D. Lagua was a former executive vice president and director of development at the Development Bank of the Philippines. He is an active member of FINEX and a long-time advocate of risk-based lending for SMEs. The opinions expressed here are his own and do not necessarily reflect the opinion of his office as well as that of FINEX.