Did you know that 63% of South African small businesses fail within the first two years? In this article we look at two factors that can lead to business failure.
1. Poor planning
Having a business plan helps entrepreneurs to plan for the future. Without a business plan, there are often challenges. Whether it’s a new business or existing one, a business plan is important to give comfort to shareholders and potential investors or to loan officers about the health status of the business and the future strategic direction that your enterprise is taking. Even companies that want to list are expected to produce a business plan before approaching the JSE listings committee, while those listing on the JSE’s main board, require an information memorandum (prospectus), which is similar to a business plan. I am trying to show here that it is not only new ventures that require a business plan, but even existing businesses should have one too.
When it comes to a business plan format, there are ten basic elements that must be covered:
* An overview of the business
* Executive summary (of all the eight topics listed below)
* General company description
* The business opportunity
* Industry and market
* Your strategy (five years)
* The management team
* A marketing plan (e.g. off-take agreement)
* Operational plan
* Historical financial information and the financial plan
2. Access to finance
There are various sources of finance, but the two most popular are: 1) the angel funds – from family, friends and successful entrepreneurs who are industry experts and 2) banking services (DFIs and commercial banks). The other two, which we won’t discuss today are venture capitalists and private equity funds. For the purpose of this article, we will stick to banking services. For those SMEs with acceptable “credit histories” and sufficient collateral, access to bank credit is easy. For start-ups and SMMEs from PDIs or any other group with limited collateral or weak credit histories access is more difficult.
I must admit, my experience in the banking industry has shown that the SMME market is a high-risk and high-cost proposition for banks. Firstly, there is the uncertainty – about the repayment capacity of SMME borrowers, with their irregular/volatile income streams and expenditure patterns. In the absence of credit information, this drives up default risk. Such problems are exacerbated by the borrower’s lack of collateral. This is primarily the reason why you have Development Finance Institutions (DFIs) like IDC, SEFA, NEF and various provincial DFIs, like ECDC in EC, Ithala in KZN, and so on. They are there to address some of the challenges raised in this article. For instance, one provincial DFI offered loans at an interest rate of 2% for co-ops taking loans up to R500 000, and prime less 5% for loans up to R5-m, including both companies and co-ops. They did not necessarily require collateral if the business met the credit scoring criteria. However, such generous terms are not guaranteed, so we always encourage entrepreneurs to develop the financial model based on commercial loan terms, assuming that you will be charged prime plus three or more because their business is high risk if it does not have a collateral and a bank can even propose a structure that can include like equity to reduce the strain on the repayments. The principle of credit extension is that a high-risk company should pay a premium (higher interest rates) – High Risk High Reward.
What does the credit committee look for:-
– Credit history of the borrower (owner and company)
– Cash flow history and projections for the business. A lender’s primary concern is whether the business will generate enough cash to repay the loan.
– Collateral that is available to secure the loan. This can be in the form of a property or investment that secures a loan so that such asset may be seized by the lender if the borrower fails to make proper payments on the loan.
– Track record of the shareholder/s. Successful prior business experience or an existing or past relationship with the lender (e.g. prior credit)
– Management capacity – experience and expertise.
– Security of supply for the stock (material) to produce.
– An off-take agreement, which is an agreement between your company as a producer and a credible bulk buyer of your product, committing to purchase or sell portions of the producer’s future production. This provides comfort to the lender that the stock produced will sell, hence it is important that you submit letters of intent from the potential buyers with your loan application, and then sign binding contracts when it is approved before loan disbursements. If the business has sufficient track record, market research and has a good sales and marketing capacity, the bank can just ask for a detailed marketing plan. It all depends on the sector as well. In the retail market, for example, a supermarket doesn’t need an off-take agreement, but a market study showing demand, correct position and ability to draw customers (marketing). These are but some of the high-level requirements. However, loan officers do a detailed due diligence (analysis) of the business before compiling a report to the credit committee, and there may be other reasons for the loan application to be declined.
In conclusion, in most instances approved loans will have conditions precedent (CPs), which must all be fulfilled before the loan is disbursed. For example, a bank can approve a loan subject to something happening, before the payout. Approval is stage one and the next stage is the fulfilment of CPs. Most SMMEs celebrate the approval but unfortunately get frustrated by the number and complexity of the CPs. After the approval of the loan, we recommend that you engage your auditor to assist you to monitor and manage the fulfilment of CPs.
For more information, contact Pastor WTM Dlalisa on 083 395 1165.
