AS A banker and advocate for SMEs, I am always asked how to secure a bank loan. For an entrepreneur, bank loans represent a versatile source of financing for the business. It can be short or long term, fixed or floating, on demand or at fixed maturity, and secured or not. It can be adapted to your needs. Obtaining it, however, poses a major challenge.
Banks are conservative because profit margins, especially in today’s low interest regime, are limited. Traditionally, banks get their supplies from their depositors and the borrower lending rate represents an increase or a spread over its cost. Of course, pricing is more complex these days, as banks aim to achieve a risk-adjusted return on their invested capital. The bottom line is that one or two bad loans can wipe out the income on a loan portfolio. Naturally, small business loans tend to be rationed.
Still, it is possible to secure 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, in particular with the branch manager and the relationship manager. The entrepreneur must lay the groundwork.
Small businesses that will eventually be successful will go through a lifecycle. 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 by equity financing or by the 3Fs: family, friends and fools. The third F may represent venture capital funding, if available. Unfortunately, there is a shortage of them in the Philippines.
The reality is that until the business stabilizes, the banker is unlikely to 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 checking and other accounts and use 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 begins to gain traction, you can begin to explore more formal financing. This usually becomes available at the mezzanine phase. By this point, you should have demonstrated proof of concept for your business to a developing and potential customer base. Your production or service delivery system should have overcome the first pains of childbirth. Your attempts to sow the seed may bear their first fruits.
Remember, however, that your first trip should have taken bank compatibility into account. What is his attitude towards the type of business you are building? What is the bank’s risk appetite, especially for the industry segment and size you represent? Not all banks are created equal.
You have to understand the language of bankers. They are usually trained in credit and one of them is likely to be subject to review according to 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 accordingly. Banks will have different valuation approaches or processes because they have different risk cultures. But the fundamentals must be the same.
When considering a potential banking partner, do not rely solely on the content of the advertisement 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 6e Credit C – connection.
Assuming you now think you are ready, be ready for the loan application process. Secure the typical application form and fill it out well. Bankers are aware of the problem of information asymmetry and will subject you to their regular Know Your Client or KYC process and due diligence. It is important not to hide critical information that is detectable.
When filling out the application form, analyze yourself from the lender’s point of view. Are the 5 Cs sufficiently respected? Your formal request should be well worded to address the purpose of the loan, how it will be repaid, contingency provisions, your business outlook, and other key information.
Remember, the goal is not just to gain the trust of your banker, but to help them defend you within the bank. The approval process goes beyond your contact and your relationship manager should be your ally. Provide your contact with information that will help you build your case.
Once you submit your request, the bank will go through its internal process. Your hope is that your banker will come back to you with a proposed term sheet outlining the terms and conditions of the loan. It’s an offer, but remember that it leaves some room for negotiation. Understand what is important to you and to your banker. And always take a long-term view, especially if you believe this is the start of a potential 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 longtime advocate for risk-based lending for SMEs. The opinions expressed here are his own and do not necessarily reflect the opinion of his office or that of FINEX.