While most small businesses start up with money from friends and family, there are still a large number that are able to convince banks to lend them money in their early stages. Banks are also a common source of finance for businesses who have been in operation for some time and who have a profitable track record.
This is not to say that getting finance from banks is quick or easy. To the contrary, the process takes time and invariably requires you to provide some sort of collateral.
Under political pressure from government, South African banks are starting to take the needs of small businesses more seriously. In the Financial Services Charter published in 2003, banks have set ambitious lending targets to demonstrate their commitment to support more small businesses in future. Borrowing money will still usually require you to provide personal assets as security, but it does leave the ownership of the business in your hands
This factsheet describes the types of loans generally available from banks, and in which situations the different packages are most applicable. It also tells you what a bank wants to know about your business and how to present this information in the most effective way.
Loans that banks offer
In general, the banks have three main loan products - overdrafts, term loans and mortgages -although they may be dressed up with different names for marketing purposes. In addition, the banks all have subsidiaries or partners who can assist with asset finance (such as leasing and hire purchase)
Some of the banks also offer factoring as a service, in which they will advance you a proportion of the money owed to you by your customers. There are also special equity funds set up by the banks to invest in small black-owned businesses that do not have enough collateral for a term loan (for instance, First National Bank's Progress Fund and Absa's Incubator Fund)
An overdraft facility provides a flexible borrowing arrangement up to an agreed maximum, which basically allows you to spend more money from your cheque account than you actually have. The purpose of this facility is to help you pay for your working capital needs - in case you need to pay salaries, for instance, but are still waiting for payment from your most recent job
The interest rate charged on an overdraft is normally higher than a term loan, but in monetary terms it is often cheaper - because you only pay interest on the outstanding balance. You will pay interest, an arrangement fee and sometimes an annual renewal fee. You may have to provide personal assets as security.
A term loan, as the name suggests, is a loan repayable over a fixed term. The term is usually geared to the expected life of the asset. Short-term loans apply to short-term assets like computers and cars, and long-term loans apply to items like machine tools. Interest may be fixed for a number of years (sometimes the entire term) or else may be linked to the base rate. The traditional advantage of a term loan (other than cost) has been that, provided you adhere to the loan agreement, it cannot be recalled. Check this with your bank when applying for a term loan, to ensure that there isn't anything in the small print to surprise you later
It is quite usual for a business to have both a term loan and an overdraft. Even if you do not need a large loan, it makes sense (if your bank is willing) to borrow at least some of your start-up capital from your bank, as this will help you build a track record with the bank. Provided the loan is paid back in accordance with your agreement, you will be building a track record that will help you next time you are looking for a loan - perhaps to expand your business
A mortgage is a specialised form of long-term loan, where the bank provides a loan for the purchase of property and takes a charge - a mortgage - over the asset. Usually, the interest rate is lower, as the bank should easily recover the value of its loan from the sale of the asset, should it need to.
Instead of waiting for your own customers to pay your invoices within a 30-60 day period, your business may be able to use the services of a 'invoice discounting' or 'factoring' firm. This is particularly useful for businesses that are growing rapidly, and are providing credit accounts to their customers. The invoice discounter or 'factor' will provide you with an advance on the value of your invoices (usually about 80%) as soon as you sell goods to your customer and generate the invoice. Interest is charged on the balance drawn, plus a service charge. In the case of factoring, the customer then pays the factor directly. If you use invoice discounting, it is possible to retain control of collection, so that your customers do not know that you are using an invoice discounter. Factoring can be an expensive way of speeding up cash flow, but it may reduce administration costs since the factor normally takes on the role of invoice clerk
Small businesses that have good prospects for fast growth and above-average returns can also look at the possibility of equity finance from banks or other financial institutions. This sort of investment is usually between half a million rand and several million rand, so the chances of accessing (or even needing) this scale of investment as a small business is very slim.Which loan will suit your needs
The starting point for assessing all your finance requirements is to prepare a detailed cash flow forecast. This will show you how much money your business will need to spend before it starts generating enough cash to keep you going. A term loan will usually be the best option for your start-up costs, as you want to begin your operations with the knowledge that there is enough cash to buy equipment and materials, and to see you through the first few months. (Also see the factsheet on Kinds of Finance)
Even after your business has started earning a healthy income, the cash flow forecast will show you those times of the month/year when you might run out of cash (for instance, when business is slow or when salaries or VAT need to be paid). These are the times that an overdraft facility would be very useful
If you plan to buy (rather than rent) your office space, banks would be able to offer you a mortgage. You should be cautious about buying property, however, until your business has taken off properly and is generating sustainable revenues. There are a number of additional costs in purchasing property (registration fees, lawyers fees, etc) that would be better to avoid while your business is getting going. Renting, or even working from home, places less risk on your financial situation.
Discuss your cash flow forecast and your financial needs with an adviser at your local business support organisation. They will be able to give advice, not only on what type of finance is required, but also on the best way of structuring the total requirement and the most likely sources of money.
The banks themselves can also give advice on the different types of finance and how they can meet your specific requirements
The risks involved in borrowing money
The major risk in borrowing is that you do not generate sufficient sales and that your business fails as a result. If you have offered personal security, you will need to sell your own assets to pay off the debt
The banks, however, would rather not have to seize your personal assets; they would rather see your business succeed. So they will expect you to demonstrate your determination and commitment, and to provide them with evidence of the likelihood of your success. Without this, they will not lend you the money in the first place. And if you can convince the bank that you are a good investment, then there has to be an excellent chance that you can succeed
Risking your personal assets
If your business already has enough assets, the bank will usually be willing to take those as security for any lending. For small loans, they may not bother with security at all
If you are a new business, however, banks will generally regard your own commitment as the main factor - and the best way of demonstrating this commitment is for you to put forward personal assets as security
If you do not have personal assets, this does not count you out. There is a loan guarantee scheme operated through the banks that you may be eligible for. Under this scheme, through money made available through Khula, the government essentially guarantees the bank's loan to you
How Khula works
Khula Enterprise Finance Limited is an agency of the Department of Trade and Industry, established to help small businesses get credit. Recognising the fact that most people wanting to start or grow a small business do not have the necessary collateral, Khula can guarantee up to 80% of the bank's loan to you. This means that, if you fail to repay the loan, the bank can go to Khula to recover the money they lent you. To qualify for a Khula-supported loan, you will still need to contribute 10% of the amount you want to borrow. This contribution can be either cash or equipment that will be used in your intended business
How Sizanani works
Sizanani Advisory Services is a part of the Banking Council, and helps small businesses to obtain finance from banks. They will accompany you to the bank to assist in negotiating working capital or a loan facility, as well as provide a year-long 'aftercare' service to make sure that your business is on the right track. Sizanani will also work with you to develop a business plan including cash flow projection, income statement and balance sheet
Once again, the process is slow, so be sure that you've got the time if you want to try this route. It will take about four months to get a loan approved, from the time that you register a Sizanani client.
The service is not free, but Sizanani does subsidise most of the cost of the services provided (assistance with bank negotiations, 12 months' mentorship, and assistance with business plan, income statement, balance sheet and cash flow projections). You will have to pay about R8,200 for the package of services (Sizanani estimates the value of the package at about R22,000)
Giving banks the information they need
The banks all have their own application forms and give detailed explanations of the information they require. In general, however, they will be looking for a business plan, which includes a detailed financial plan
. If you are starting up and don't have a track record from a few years of trading, this will be essential
If you are already in business, the bank will want to see a history of your accounts - usually for the past three years. In addition to this, it will also need to know how the money is going to be used
The business plan needs particularly to describe your customers and why they should buy from you rather than your competitors. The financial forecasts need to show how much you need to borrow and also demonstrate that there will be enough income to repay the bank within the agreed term
More to think about
Think carefully about how much you need to borrow, as you will need to ask for a realistic amount:
- If you request too little, your business may not be able to achieve its targets because you are strapped for cash to do the necessary marketing, etc. And it is difficult to ask for more later; as the bank might not be encouraged by your progress to date
- If you ask for too much, the interest charges may be too much for you to repay. If your financial requirements are irregular or seasonal (you may only need a small loan right now, but later you'll need to spend larger amounts on big orders and advertising), then discuss this with the bank and agree an arrangement that gives you the flexibility you need for a cost you can afford.Remember that if you can start trading with your own money, and can show progress (and hopefully a profit) from your own efforts, a bank will consider your application more favourably. Once you are in business
- Talk to the bank as soon as you know that you will have to borrow - don't leave it until the last minute
- Have a business plan to show the bank, and be very familiar with what is in it - you need to talk with confidence about the details of your plan. Even if you have a consultant help draw one up for you, make sure you engage fully in the process
- Keep accurate records - this will demonstrate to the bank that you are in control of your business affairs; and
- Update your financial forecasts to give the bank confidence that you are adapting your requirements with the real situation experienced by your business.
If you have a bad credit record
If you have a bad credit record, even from a long time ago, it almost automatically disqualifies you from getting bank finance. Do everything you possibly can to settle your old debt and clear your name. Apart from that, the only thing you can do is to be totally open and upfront about it. Don't try to hide it.