Raising funding is something that every entrepreneur needs to consider when they are growing their business.
However, the challenge is that few small businesses get the funding they so desperately need, and the main reason for this is that they are not able to supply the supporting documentation that lenders use to assess the funding risk or that they do not meet the lenders’ risk assessment criteria.
To better understand what you can do to always be ready to raise funds requires that you understand the different types of funding and how they are assessed for risk.
Depending upon the type of loan, the risk areas differ. For example, if you are trying to raise money to buy equipment, then the risk lies in three areas. The first is the type of equipment you intend to buy and the question lenders will ask is whether this equipment is widely used and can therefore be easily sold to recover the some of the cost of the loan if you default on payments. The second area of risk is whether the business can afford the repayments and the third area is what assets do you own (eg house, car, insurance policies) that can be sold to cover the outstanding cost of the loan.
Now, imagine you have a contract with a large corporate or government department. You have finished the work but know that you will not be paid for the next 60 to 90 days. This negatively impacts your cash flow. In this case, the easiest way to raise working capital is to apply for an invoice discounted loan. Lenders will loan up to 80% of the value of the invoice and you repay this amount when the client pays the invoice. Therefore, the risk lies in a completely different area. Lenders will want to know who the client is (so that they can check the payment/credit history of the client) and that the client is satisfied with the work that you have done (in other words, the invoice will not be disputed). Whether your business is making a profit or not, is irrelevant to this type of loan.
Lastly, let’s look at term loans. This is a loan provided for a fixed period of time. In this instance, lenders will want to know several different things before they can fully assess the risk of lending you money. They are concerned with:
Your trading history and profitability
Cash flows (that show you can easily afford the loan)
Security (assets you own that can be sold if you default on payment)
Owner’s credit rating (how likely are the owners to repay their debts)
As you can see, different types of loans use different credit risk models and understanding the risk models helps entrepreneurs select the most appropriate types of funding for their needs.
Keep in mind that raising funds is also about building trust that you will repay the loan. Given that lenders do not know you or your business, your job is to provide the documentation that helps them assess you in a positive way. This means you need to have good record keeping and administrative systems in place so that you can always produce:
Up-to-date management accounts
Up-to-date cash flow statements
Up-to-date tax clearance certificate
Up-to-date assets and liabilities statements for all owners
Good credit records for the owners
If a business cannot produce management accounts, it gives a big warning sign to lenders. After all, how can you run a business if you don’t know how much money you have available to you? So, take the time to constantly update your accounts information so that you can always produce an up-to-date income and expenses statement, balance sheet and cash flow.
Most lenders what to know that you are running a good business and governance is a key part of that. Therefore, an up-to-date tax clearance certificate is important as it shows that the business is legal and pays its taxes on time.
The business needs to keep an up-to-date statement of assets and liabilities for each owner. This also needs to include a copy of marriage certificates as if an owner is married in community of property, then their spouse owns 50% of their assets (lenders would need to know this). As a rule of thumb, it is worth contacting owners on a quarterly basis to see whether there are any changes to their assets and liabilities and marital status. Remember that lenders want to know that business owners are also putting some “skin into the game” and making them sign surety for a loan is a common way of doing this.
Lenders use credit records to understand how responsible or accountable business owners are when it comes to repaying their debts. The majority of lenders will not fund business owners with poor credit records, as they perceive the lack of payment of previous debts as a danger sign. Remember to check your credit record (you are allowed one free record per annum) and then do everything in your power to clean it up. If you do have outstanding debts, then negotiate a repayment plan with each creditor (make sure this is documented and signed), so that you can make a case to show that you take your responsibilities seriously and honour your debts.
Keep in mind that lenders are running a business and, just like you, they need to generate profits from their business. They want to ensure that they lend money only to those businesses that can afford to repay them.
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About the Author
Robynne Erwin is a Fetola mentor.
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