Looking for a bank loan

I want to grow my business and need funding. Like many small businesses, mine doesn’t have the growth prospects that would attract an investor, so I’m thinking about getting a loan. But all the reports in the media suggest that banks aren’t keen to lend to small businesses at the moment. What can I do to increase my chances of getting a loan?

Free guides

Editor's Choice

A. Robert Copping writes:

The Bank of England has recently reported another quarterly decline in lending to small and medium-sized businesses, although the British Bankers Association says this is due to falling demand as companies focus on reducing debt. Business minister Vince Cable believes there is a problem with the supply of credit and that it could derail recovery more than any other factor.

With the government having large stakes in two major banks, you’d expect more pressure to lend, but lenders can’t take undue risk when this was one of the causes of the credit crunch.

A lender’s reward is limited to the interest charged and a bank might earn only 3% to 5% above the cost of the capital loaned. Suppose a business borrows £100,000, but it goes bust after only repaying half the loan. The bank would have to lend £1.25m at 4% for a whole year with zero risk just to make up for the loss.

This is the reason banks are so risk averse and why they look for security as an alternative way to recoup the debt in cases of default. For smaller companies with minimal assets, this typically means having recourse to the personal assets of the owner(s). So, the way to improve your chances of securing a loan is to show that the risk of default is low.

Here are some of the points a lender will consider:

Does the trading history support the level of debt being requested?
What is the level of interest cover? (The number of times operating profit can cover interest payments on existing debts plus the new loan)
How will the loan be spent and will this directly lead to increased revenues and profits, and hence the ability to repay the debt?
How strong is the financial management of the business?
What level of security or personal guarantees can be called upon if the business defaults?

Your finance strategy should be to only borrow what your trading position currently allows. As you grow, you can borrow more to finance further growth.