Ask Dr. Jana | To Borrow, or Not to Borrow?

April 24, 2020

Q.

Dear Dr. Jana,

I had to let most of my employees go, but promised to do everything I can to bring them back as soon as possible. I signed up for the JobKeeper program, but with no revenue and the requirement to keep paying the remaining employees until the JobKeeper funds arrive, we are running out of money. Up to now we have funded our company’s growth by investing profits back into the company. We have never asked the bank for a business loan, but now I think I am going to have to because I won’t have enough cash to get through.

I’ve heard the banks are offering loans with no repayment for six months. How do I know whether we would be eligible? How much should I ask for, and will I need to pledge my house? I don’t want to waste my time and be told I don’t qualify. 

– Shaun

A.

Dear Shaun,

The Reserve Bank of Australia and the Australian government have made $40B available through the SME Guarantee Scheme for banks to loan to small and medium-sized companies with a turnover of less than $50 million that are based, registered, and operating in Australia. The purpose of the loans is to provide working capital. You would use this loan to buy the supplies to make and sell the products or provide the services that generate your company’s revenue, pay for rent and electricity, pay your staff – but not to pay off current loans or for your personal use.  The good news is that this loan will not require a personal guarantee, so you will not need to pledge your house or any other personal assets.

If you’ve done what I recommended in the very first Ask Dr. Jana column, Five Steps to Increase The Odds Your Business Will Make It Through, then you will know whether and what month your expenses will be more than your income – and whether your cash flow problem is going to last for one month or for the foreseeable future. You will need to take those financial statements (Profit & Loss, Balance Sheet and Cash flow) with you when you visit with the banker to talk about your company and apply for the loan. I talk more about the size, types and eligibility criteria for business loans and whether they are the best solution for you in my article below.

Dr. Jana

 

Size and Types of Bank Loans

The size and type of loan will depend on how much you need and whether you need it immediately or need to have access to cash to cover a shortfall now and then.  With a business loan you get the money immediately, and it begins to accrue interest the moment it’s transferred to your company’s bank account. But if you only need a loan to cover a cash shortfall in a month when customers pay late, or you have an exceptional expenditure, you may be better off with an “overdraft” i.e., a line of credit to borrow from when you need the cash, then pay back in the months when you have extra cash. This will minimise any interest you will need to pay on the money borrowed.

Different banks offer different features and benefits around these two types of loans.  For instance, ANZ is offering a three-year business loan for up to $250,000, with loan payments deferred for six-months with the interest added on to the loan amount. It is also offering a six-month business “overdraft” for up to $250,000, with interest deferred for six-months, at the end of which you have the option to repay the overdraft and interest or roll over the balance into a term loan and pay it off within 2.5 years.

Inexperienced CEOs may be tempted to borrow against their credit card. Although it’s quicker, easier and you don’t have to worry about being turned down (assuming you stay within your credit limit), I don’t advise doing that. The interest rate is about 20%, and you get charged from the moment you take the money out. It’s much better to go see a banker and develop a banking relationship.

What determines whether you are eligible?  

Bankers look at 4 C’s to determine eligibility for a loan.

1. What is the Character of the business (and the owners)?

How big is the business? How long has it been operating?  When did it become a customer of the bank? Where is it located? How many employees does it have? How is it structured?  Does it have lawsuits, liens, or negative media?  What are customers saying about it? What’s its credit history and has it paid its bills on time?  Is the CEO or owner(s) willing to share information about the business? Has the CEO or owner(s) ever filed bankruptcy or gone into liquidation? All this information provides the banker with insights into the “character” and “trustworthiness” of the business owner.

2. Does the company have the Capacity to pay its bills?

How healthy is the company’s cash flow, and profit and loss statement? How strong is its balance sheet, i.e., does it have more assets than liabilities?  How much debt does it have and who does it owe, e.g., owners, other banks, or other entities? How many lines of credit are outstanding?  Any defaults?

3. Will the company have the Capital to pay back the loan when it comes due?

Under normal circumstances, the banker would be trying to determine how much your company can afford to borrow – and if your company were to go under, how the bank could be repaid. You would need to demonstrate to the banker that, at the end of six months, there would be enough cash flowing into the company to begin making payments on the loan. And if that looks questionable – as it does when you are a new company with no track record, or a company that’s in financial difficulty – the bank will ask for some collateral or “security” for the loan, i.e., you would need to agree to secure the loan with money from your savings account, stocks, bonds, property – and that could include your house or your farm. But for the SME Guarantee Scheme loans, the government is guaranteeing 50% of the loan and the borrower does not need to provide an asset as security for the loan.  This means the banker can be more lenient on this “C”, but they will still expect to see your business plan, your financial plan and need to understand how and when you expect to be able to pay back the loan.

4. What are the Conditions facing the business?

The final C has to do with the externalities impacting the business. All companies are being impacted by CoVID-19. But as the old saying goes, “It’s not what happens to you that matters, but how you respond to what’s happening.” Some companies are doing well and actually need more cash for growth, e.g., grocery stores, companies doing video streaming, those making protective gear for hospital workers, and manufacturing camper vans!  But most companies are in financial pain and whether that’s temporary or long-term will depend on how you respond and whether your company already has the basic business building blocks in place that will support the survival and future growth of your company.

A loan may help you get through a rough patch, but will not, in and of itself, solve your problems. So, in answer to your questions, the government, Reserve Bank, the banks – all of us want you to stay in business. Explore the many state and federal grant programs that are being offered, including some that are outright cash grants. And go see your banker and ask if there are any short-term bridging loans, like the ones ANZ is making available, to help customers get through until the JobKeeper program kicks in, as well as the larger SME Loan Guarantee Scheme.

But before you go, run your company through the 4 C‘s and look at your company through the eyes of your banker. Don’t be discouraged – very few companies ever score a perfect 10 on every element, and especially now when most companies’ capacity to pay their bills has been severely impaired. But be prepared for the questions the banker may ask, describe how you are using this “down time” to take a hard look at the business, identify where changes need to be made and your timetable for making them. Show the banker how a loan will enable the company to come through this crisis as a much stronger company – and how your new “lean, mean fighting machine” company will be able to pay back the loan and interest, bring back employees, and get back on the growth path.

Ask Dr. Jana your questions on company survival and growth. Submit your questions via email to Dr. Jana and she’ll answer in her ‘Ask Dr. Jana’ column.

Learn more about the programs delivered by the Australian Centre for Business Growth.