subject: Financial Security For Business Directors And Why Banks Don't Want To Lend [print this page] Financial Security For Business Directors And Why Banks Don't Want To Lend
There's been a lot of criticism of the banks in recent years. Many owner/finacial directors can't understand why banks won't give them overdrafts or loans to financial planning and grow their businesses. Well the answer lies around the bank's position on financial risk, the security available, the financial commitment and ability of management and, to a lesser extent, the economic cycle generally.
The first thing you need to know is that a Bank is not a financial risk lender. What this means is that banks won't advance money to you and me, or a business, unless there is a high degree of certainty that the money will be repaid on their part. To provide this financial certainty, they will almost always want security. So what is this?
Think about the time when you wanted to borrow money to finance the purchase of your home. A bank or a building society will normally offer loan services, as long as three key conditions are met:
1. The loan is restricted to a specified percentage of the financial value of the house
2. The house is pledged to the lender until such time as the loan is fully repaid
3. You must show the ability to make financial repayments against the loan.
In this example, the security is the pledging of the house. If you default on the loan repayments then the lender has priority before any other person to take possession of the property and sell it to repay the debt. Any financial surplus would then be returned to you.
Bank lending to businesses is no different. The same key conditions apply. The difference is that most businesses don't own the property they occupy. So financial security has to be found elsewhere.
In years gone by, many businesses obtained their finance through the banks overdraft facilities. As security the banks registered a debenture over the company's assets giving them "a fixed and floating financial charge" over the company's assets.
A fixed financial charge means that a lender has priority rights over a specific asset, like the property example above. With a floating charge, the lender ranks after certain preferential creditors; therefore it doesn't give the same part of protection to the lender in the event the latter has to recover its financial borrowing.
Property apart, the main asset in a company is usually the finance due by its customers, known as trade debtors, book debts or accounts receivable. There was a time up until a few years ago, a bank was able to secure its financial lending with a first fixed charge over book debts. With a high proportion of debtors usually recoverable in the event of a customer entering insolvency, banks were often prepared to provide financial support by way of overdraft.
Due to various legal judgements, this is no longer the case. Only if book debts are paid into a separate account by the financial director over which the lender has control, as opposed to mixed with other monies in an overdrawn account, will a lender have first call on book financial debt recoveries in an insolvency.
This has resulted in a huge increase in business for companies such as Factors and Invoice Discounters who specialise in lending against book debts. On the other side, financial lending by banks on overdraft has greatly contracted.
Financial overdrafts and loans are of course still available, but security is sought outside the business. This is normally by way of personal guarantees from the business owner/finacial director frequently supported by charges over their homes. If you as a business owner/director are not prepared to give this security, it is unlikely you will get the finance. If you do not have the confidence to back your business by putting your finance/assets on the line and where your mouth is, why should the lender?
That said, a bank has a responsibility to ensure that the do not enter into such commitments recklessly and that you take professional financial planning advice. Although the security lies outside the business, it is the business that is expected make repayment. The bank will therefore carefully consider the prospects for the business, review any business plan and make an assessment of the capability, experience and past record of the director and management team.
In a time of economic downturn, the risk of default on financial borrowing is greater as businesses start to suffer lower profitability. The value of security often drops, the ability to repay reduces and risk increases. Although the business may have a need for additional borrowing, for all the reasons above the banks' attitude to lending will harden.
It is easy to blame the banks for their part in the problems they have caused within the economy, but it would be equally wrong for them to support businesses which are failing. In keeping with Charles Darwin's theory "Survival of the fittest", recession provides the stage to get rid of the weakest and poor performers whilst providing opportunities for the best.
