Cautious lenders equal tough times for SMEs

This article was current at the time of publication.

Small-to-medium enterprises (SMEs) looking to bolster their balance sheets have several debt and equity options but considering them may not be where the full story starts.

CEO of Auckland accountancy practice DVA Matt Vincent CPA says the bulk of his firm’s business clients have revenues of $1 million to $2 million and sources of new equity capital are essentially limited to family or friends. 

“In lots of businesses we come across, the owners draw significantly on the business,” Vincent says. “But are they generating enough revenue and margin to cover shareholder remuneration?”

He says it’s become harder to secure bank loans because of the 2022 amendments to the Credit Contracts and Consumer Finance Act (CCCFA), which require lenders to make “reasonable enquiries” before entering into arrangements with borrowers. 

“There are more questions from banks and mortgage brokers. For business owners trying to borrow money for any purpose, there are considerably more hoops to jump through.”

However, before even approaching a lender, business owners and their advisors need to question the root cause of cash flow problems.

Cash control levers

Many levers can be pulled within the business to control cash, Vincent says.

Can debtors and inventories be more tightly controlled? Can you negotiate better terms with suppliers? Are sales levels too low for your business model?

Businesses that fully understand their cash flow cycles will be able to approach a bank with fully informed knowledge of what the requested loan is for.

Saying you’ve got upcoming expenses just isn’t going to cut it because that’s the last thing banks want to hear.

Other options for SMEs

As Vincent points out, there are other options too, including sourcing grants and government funding and checking whatever tax relief avenues may be available.

Deferring capital expenditure is another, but businesses should consider whether vendor finance is appropriate for assets such as vehicle purchases.

“They don’t necessarily offer a better interest rate, but the security hurdles you have to jump through are way fewer than those for banks,” Vincent adds. “Typically, security is only over the asset purchased.”

If you do decide to raise fresh capital, options range from “vanilla” debt to ordinary equity, says Northington Partners Director Ricky Meyers, a mid-market investment bank and corporate advisory firm.

Whatever best suits will inevitably depend on the level of control granted to any provider or investor, the upfront value received from any equity and the ease and speed of execution of the capital raise.

Vincent agrees that complexity and loss of control are major issues.

“Not many small business owners would give up a slice of their business so someone else can receive a dividend,” he notes.

“With all the legalities and the work setting up agreements, it’s not much of an option.”

Meyers says options for firms at the higher end of the SME scale include private equity, family offices, high net worth individuals, or other trade players.

These might help to grow the business, bring credibility through backing, and supply access to experienced governance.

On the other hand, raising equity can take longer to complete than debt because due diligence requirements are often more onerous, Meyers warns.

Bank lending appetites

There’s limited evidence yet that, aside CCCFA issues, banks have become more averse to SME lending.

The Reserve Bank’s Credit Conditions Survey for the six months to September 2022, published on 21 October, said banks’ credit availability and lending policies for SMEs (defined as turnover of less than $50 million) remained broadly unchanged and in line with the historical average.

“Allocation of capital has been aligned to banks’ risk appetite for various industry sectors,” the report notes, asset quality in the SME sector remained solid.

However, the Reserve Bank continues, “the recent increase in the utilisation of working capital credit limits could point to emerging serviceability stress in the near term” and “there could be lagged stress coming through as the lending book reprices” – in other words, as loans roll onto recent higher interest rates.

“Banks are willing to support viable existing customers with credit lines and work with any potentially stressed clients rather than foreclose on them outright.”

Kaison Chang CPA, a director at Auckland-based Thorne Accounting/Margin Gains, says many businesses will become exposed to higher interest rates in the second half of this year.

Thorne Accounting/Margin Gains’ client base is “90 per cent property-based,” says Chang, and for them the issue is not about equity but about loan serviceability.

“The vast majority are looking to weather it by talking to their banks, maybe switching from interest plus principal to interest-only, or looking at having to sell one or two properties.”

Banks “have definitely been a lot stricter” on lending due to the CCCFA rules, he notes.

CPA Australia has two guides for small business clients looking to access finance: Applying for a loan factsheet and Access to finance – tips to guide small and medium businesses.