To borrow or not to borrow?
That is the question most SMEs are asking themselves right now. Whether you are considering the IRD Small Business Cashflow Scheme or the larger Business Finance Guarantee bank loans it is important to remember they are loans, not grants, and carry obligations. It is not a straightforward decision, there is good debt and bad debt. Here are five factors to consider before you apply for a loan.
All lenders, including the IRD, will require you to say your business is viable going forward. Many SME owners will grapple with this question. Where is the new normal, what sales revenue can be expected and where will the market surprises come from? Perhaps the best available response for many will be that it was viable beforehand. Assuming the market returns to some form of normality, as before, it can be viable again. SMEs cannot predict what is ahead, so lenders should accept a qualified response to that question.
At the same time SME owners need to be realistic about their businesses and ask themselves some tough questions. Was my business really viable before the pandemic, or just barely surviving? Too many businesses have utilised "just in time" principles, not just for their inventory management, but also for their cash management. In this market that model will not be robust enough. SMEs will need cash and inventory reserves.
Will these Loans be good debt or bad debt?
Good debt is for investment into income earning assets that will repay the debt and more. It may be borrowing for a shipment of inventory, knowing that the sale of those goods can repay the debt at a good margin, or borrowing for new equipment that adds to income and has a payback period matching the loan term. The outcome of the new loan should be that you increase the net worth of your business.
Bad debt is borrowing to pay operating expenses such as salaries and rent, with no significant lift in income. You are just left with a debt to repay and no matching asset. However, in this strange market, the loan purpose may be to buy time. Given the current situation that is a valid proposition for small loans, it is necessary debt. But beware, this type of debt is never a long term strategy. If your critical timeframe is the next month or the quarter ahead then extra debt may be essential but make sure that the loan amount is affordable relevant to the business size and can be repaid. Don't just add a liability that is unaffordable for your business and as a result give false expectations to staff, suppliers and customers.
What type of loan is best?
Wherever possible, link the loan terms to underlying business activity. For most the need will be immediate working capital needs. That requires a flexible revolving credit facility.
Reduce the loan whenever possible from cashflow and ensure you only pay interest on the daily balance. In an ideal world that facility should be linked to actual trading activity, for example a flexible limit indexed to an agreed percentage of the businesses' accounts receivable and inventory. This form of asset based collateralised overdraft is available overseas but rare in Australasia. In today's market with extensive use of online accounting packages it is easy to share detailed trading information regularly so that the lender can have increased transparency and manage the loan limit accordingly. More integration of this technology should be developed by lenders.
The IRD Small Business Cashflow Scheme is a fixed amount with a flexible term and will be helpful for initial liquidity but borrowers must plan to repay over time. In my opinion the Government should consider a loan forgiveness step, partially or in full, after 12 months if there is clear evidence the business has suffered significant impacts from Covid19 and the funds were used in the business rather than drawn for personal use by the SME owner.
Financing longer term assets, such as new equipment needed for a long term contract, should be financed by long term instalment based finance.
Another source of finance for SME owners is suppliers who allow credit terms. Be honest with your suppliers and don't enter into credit commitments that you cannot afford to pay. It is important that we all protect our supply chains.
What is the easiest process to get a loan?
The IRD Small Business Cashflow Scheme loan terms and process were recently announced. It is a similar online application model to the Wage Subsidy. It applies to all businesses with 50 or less employees with a starting point of $10,000 plus $1800 per fulltime employee.
Banks are participants in the Business Finance Guarantee Scheme which allows loans to $500,000 on normal bank criteria and the Government will underwrite 80% of the loan risk. Initial feedback is that these loans are not easy to access, despite those very favourable risk terms and some additional loosening of the rules. Talk to your bank but be prepared for a lengthy process.
Non-bank finance entities are still lending money and have been consistently strong supporters of the SME sector. The Government should move immediately to include them in the Business Finance Guarantee Scheme, perhaps to a lower level of $250,000. Consider your finance need and talk to these non-bank entities for asset finance or look for working capital providers such as factoring or purchase order finance.
There is No Free Money
Any loan, including the IRD Small Business Cashflow Scheme, has obligations attached. It is not a grant, you have to repay it. Borrowers should have a repayment plan when they commit, either a revolving facility, regular payments or structured lump sum payments, but always ensuring they retain enough cash for their daily commitments.
All SMEs need to pause and consider their options carefully before taking on any extra finance. Seek professional advice from your accountant and mentors before proceeding.
The Government need to be constantly reviewing their packages to assess what is working and how improvements could be made to their SME support packages. They need to engage with a wider audience to understand what the needs of SMEs are. Initial steps should include allowing Non-Bank Financiers to participate in the Business Finance Guarantee Scheme and consideration whether the IRD Small Business Cashflow Scheme should have a forgiveness portion at a future date if revenue is down by a large amount over an annual period.
- Simon Thompson is an international specialist in Access to Finance for the SME sector.