Everything you need to know about credit and your small business

Credit provides an effective way of financing for small businesses from its early stages or into its next growth phase, but while traditional forms of credit may appear to be the intuitive “go-to” for small business owners, bank loans tend to be notoriously difficult to secure.

“As a small business financier, we deliberate over small business finance in less of a ‘tick-box’ manner and more on a ‘case-by-case’ basis, taking into consideration not only top-level metrics such as cashflow and financial viability, but also the skillset and business acumen of the entrepreneurs we work with,” Jeremy Lang, chief investment officer at Business Partners Limited, says.

Recent statistical data from the South African Reserve Bank reveals that bank loans to SMEs currently only make up 25% of total business loans. Loans and advances to businesses decreased during 2020 and fell by almost 6% in early 2021, with credit conditions reflecting the uncertainties of the mid-pandemic economic climate. 

The Organisation for Economic Co-operation and Development (OECD) attributes this relatively low level of credit deployment to the fact that banks are, by their very nature, risk averse and governed by stringent underwriting criteria.

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Small business start-ups are a substantial risk

Lang says entrepreneurs, particularly those who start their first businesses, represent a substantial risk compared to the lower risk associated with larger, more established companies with commercial credit histories.

“On the other end of the spectrum, micro-businesses that employ five or fewer people have better access to personal lending facilities, microfinance funding and government grants.”

However, a significant percentage of South African SMEs fall within the earning bracket of between R1 million and R100 million in turnover, with staff complements of between one to 35 people. These ventures are what McKinsey & Company refers to as the “missing middle”.

These SMEs find themselves in a position of being neither small nor large enough to be viewed as valuable prospects for traditional lenders, with non-bank, independent SME financiers and angel investors filling this prevailing “credit gap” which, was estimated at US $30 billion for South Africa according to an International Finance Corporation 2019 report.

Lang says in the future, non-bank lenders and players, primarily within the emerging FinTech sector, will continue to play a significant role in providing access to funding for entrepreneurs.

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Support for small business owners beyond rands and cents

SME financiers, such as Business Partners Limited, are also positioned to go beyond “rands and cents” in providing support for SME owners.

According to the most recent Business Partners Limited SME Index, there is a growing need for SME-specific information, resources and support in areas such as funding and business strategy.

Therefore, education and mentorship initiatives can play a key role in helping fledgling entrepreneurs navigate the often-complex arena of financing and how to use responsible lending to grow and develop an SME, which is even more important.

“Institutions have different requirements that determine whether entrepreneurs qualify for credit. Financiers also have their own objectives, such as industry preferences, transaction sizes, collateral requirements and impact and/or commercial return expectations.”

SMEs can use financing from Business Partners Limited, for example, to expand an SME through increased working capital requirements, finance an asset purchase, finance a business takeover, buy commercial property or renovate an existing commercial property, or even buy a franchise, Lang says.

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Documents required for small business funding

The documentation required to apply for business credit will also vary from lender to lender and basic financial documents will be requested as a standard requirement, including a business plan, cashflow history and projections, as well annual financial statements and up-to-date management accounts.

The entrepreneur’s personal documents, such as their ID and marriage certificate will also be requested. Finally, the lender will request admin-related documents, including company and tax registration documents, office leases, shareholder agreements and business licenses.

A recent assessment of the local small business landscape by industry body, SME South Africa, revealed that some of the main reasons why entrepreneurs are denied funding include inaccurate or incomplete financial statements, inadequate proof of a healthy cashflow and bad credit scores.

“Non-bank SME financiers, such as Business Partners Limited, are generally nimbler and more adaptable to different levels of types of risk when compared to banks, but this does not mean that our due diligence is not as thorough as traditional lenders.”

He says as a first port of call, the organisation will establish the financial viability of the small business and therefore entrepreneurs are advised to ensure that their business plans, forecasts and cashflow documents are professionally presented and detailed.

“Applying for funding can be a daunting task, which is why preparation is key. Do your research, ask for advice from experts and lean on the experience of successful entrepreneurs.”