SMEs should bide their time while shopping for loans
Imagine as a business owner you have finally managed to get through a bank’s portals, gone through a tortuous negotiating process with the relationship manager and are finally sitting down to sign up for a credit facility. While all of the above represent the hard yards, the question then emerges: “How much should I sign up for and for how long?”
“Currently, interest rates range from 9 to 12 percent with upfront processing fees in the region of 1 to 2 percent on gross facilities sanctioned, always depending on the quality and complexity of the credit,” said Vikram Venkataraman, director at Salvus Capital and formerly a banker with an extensive SME financing experience. “The average interest rate is around 10 percent plus, and the actual rate also depends upon whether there is a banking track record or not, risk assessment of the underlying business, cashflow projections, etc. As the borrower demonstrates a good conduct of the account (i.e., timely interest payments) as well as achieves projected performance, banks get more comfortable and rates tend to reduce.”
Even then a business owner would do well to shop around for what he considers optimum rates and the terms and conditions that come along with it. These days, banks are under pressure to extract the optimum possible results out of their assets and the chances are they would be more than willing to tie up with small and mid-sized businesses that are still building up towards a decent track record.
So, the only rule of thumb that applies for a business owner is to bide his time. Venkataraman defines it as the “luxury of time”. “Very often SMEs, particularly those in a growth phase, tend to take what is available rather than invest time and effort in getting the lowest rate,” he said. “It is important to note that the selection of banks must not be made solely on the basis of the interest rate. There are many other aspects to starting a bank relationship. Our advice to first time borrowers would be, focus on the financing and security structure, rather than pricing. One can always negotiate with a bank to lower rates after building credibility.” Of course, the business the SME is in and the track record it has managed to achieve will always determine how much banks are willing to offer and at what terms. Clearly, the experience differs dependent on whether the business is into trade or manufacturing.
“In most cases, SMEs in trading and manufacturing get bank facilities — mainly letter of credit (LCs) and trust receipts (TRs) — at between 6 to 14 percent annum,” said Jitendra Gianchandani, chairman of Jitendra Consulting Group (JCG). “In comparison, the big groups would be getting rates of 5 to 6 percent due to their reputation and stability. “Other SMEs with a track record of three years can expect to tap rates of 8 to 11 percent per annum on submission of their audit reports.” Again, it is all based on the type of business. According to market feedback, SMEs in the service industry tend to get hit rates of 22 to 26 percent per annum. They would also need to furnish their bank statements and ensure they do not have a history of bounced cheques.
“I operate a small advertising firm and I always get the impression that when banks talk to us, they carry the impression the business is bound to fail at some point,” said an owner. “And the rates I get saddled with tend to carry a steep surcharge based on that assumption of the bank. It’s something I am always fighting against.” According to Gianchandani, “Unfortunately, today most SMEs are managing their finance from banks via business loans for their working capital requirements which is charged between 22 to 26 percent, with the processing charges and insurance being separate.”
Those terms can be a burden on SMEs that are yet to attain a degree of momentum for their operations. For these business owners, tapping into own equity would represent the most viable option. Another would be to have the luxury of time as Venkataraman calls it to engage with a bank and work out terms that can put both parties in a win-win situation. And get into a relationship that amounts to much more than a transitory one.