Ask your friends or colleagues how banks make most of their money, and they’ll likely say it’s from the interest they collect on loans.
And they would be wrong.
Thanks in part to several years of low interest rates, banks only make approximately one-third of their revenue from lending; the majority comes from fees and returns on investments. This can make financial institutions more discerning when it comes to providing commercial loans, especially for financing involving exporting or international investments, which have added risk.
That’s just one example of how banks have changed, and how you need to change your strategy to talk to your bank and get the business financing you need to grow your international sales.
As the Regional VP for the Bank Channel at EDC, I work daily with financial institutions, getting a first-hand view of how they work. One piece of advice I give to entrepreneurs and smaller businesses is to understand the difference between being bankable and being lendable. All companies with financial data are bankable—you can open a business account and deposit revenues and pay your company’s bills.
But not all businesses are lendable, meaning that they can get financing or loans. To be considered lendable, you typically need one or more of three things:
- Your company must be mature enough to provide three years’ worth of financial statements. Obviously, that means your company needs to be at least three years old before you can even think about getting a loan. (Don’t worry— credit insurance provides a way to get around this, which I’ll explain shortly.)
- You must have assets, inventory or accounts receivables to provide as collateral.
- You must have a minimum risk rating, and that measure is fast evolving as banks begin to use new methods of determining creditworthiness.
With today’s low interest rates for small business loans, it’s more cost-effective for banks to supplement their due diligence with behavioral models to help determine your company’s creditworthiness. In a nutshell, the bank uses analytical data on companies matching your demographics to see how creditworthy similar companies are. Nevertheless, you’ll still need to provide a solid business plan and do your part to convince them of creditworthiness.
On the plus side, banks also use this data to improve services to their commercial customers, such as offering sector-specific solutions and predicting the tailored financing you might need for your future requirements.
The scope of this blog can’t cover the several disruptive changes that are evolving commercial banking, such as FinTech (e.g., new financial technology such as cryptocurrencies) and new, small competitors such as Thinking Capital, Merchant Advance and Lendified, which offer small business loans online in as little as a day. I’ll save that for another blog. However, it will suffice to say that to be competitive, banks are focusing on what they do best. Learn what the different banks offer and choose the one that best fits with your company’s goals.
For example, commercial banking is divided into three types:
- Large corporate deals that involve more than one bank or entity
- Small business banking
If you’re a start-up, then choosing a bank that specializes in small business banking will be a plus.
For a small business line of credit, banks typically ask for $2 in collateral for every $1 in loans. Collateral can include:
- Capital assets: These can include real estate, equipment, etc. Banks don’t generally like to accept assets as collateral, simply because they are harder to liquidate.
- Inventory: Banks usually will accept inventory as an asset for 50 cents on the dollar. Canada is the one of only a few countries that accept this.
- Receivables: For domestic receivables, a bank may give you as little as 65 cents on the dollar, and zero for receivables outside of Canada. However, if you have credit insurance, you will typically get 90 cents on the dollar for both domestic and international receivables.
No matter how much due diligence a bank undertakes, it’s impossible to predict which companies are creditworthy with 100 per cent accuracy. That’s why you may get turned down, no matter how awesome your company is. Rather than try to convince them you’re not a risk, it’s easier to take the risk away.
The first step is to do what sound business and fiscal management has always dictated. Ensure your company is meticulously managed and your business plan is solid, with an international sales plan you can manage. Attain and keep a pristine credit rating.
The second is to be aware of the tools you can use to take away or share the risk with the bank, and bring these into the conversation:
- Call EDC first: We can advise you on how EDC’s solutions can work with you and your bank. We may even go to the bank with you!
- Risk mitigation, such as credit insurance (sometimes called Accounts Receivable Insurance): If your U.S. or international customer is unable to pay you due to bankruptcy, for example, and you have credit insurance, you’re covered for up to 90 per cent of your insured losses. Having solid insurance on your accounts receivables, such as EDC credit insurance, will help you increase your financial leverage, and some financial institutions may provide you with contract-specific business financing—even if you’re a newer company or can’t provide other collateral. As I mentioned above, banks will increase the value of your receivables as assets if you have credit insurance.
- Risk sharing: If you need more working capital to finance sales in new markets or buy equipment, EDC’s Export Guarantee Program (EGP) can provide your bank with a risk-sharing guarantee covering up to 75 per cent of your line of credit. And if you need a loan for an acquisition abroad, the EGP can guarantee 100 per cent of the loan. The EGP also allows you to invest in research and development by borrowing against the value of your R&D tax refund.
- Risk transfer: Doing business often requires a company to post standby letters of credit, such as performance bonds, which require collateral. EDC can provide guarantees on the bonds so no collateral is required, freeing up working capital for your company. EDC’s Account Performance Security Guarantee is the only solution in Canada freeing up collateral tied to international contracts.
If you’re approved by your financial institution, the credit facility granted is typically 10 per cent of your revenue. So if your company’s financial statements show that it made $1 million on average over the past three years, you can expect a loan or line of credit for $100,000.