Why the Government's SME lending schemes are not as good as they seem

May 1, 2012 - PRLog -- While the new and much publicised Government National Loan Guarantee Scheme (NLGS) was trumpeted by George Osborne as the delivery of a promise to help small businesses with financing, the reality appears to evade the issue, says Lake Falconer:
The scheme misses the point completely by providing a small reduction in borrowing costs when the real issue is access to finance, not the cost of finance. From my discussions with local business owners, there is also confusion with the Government’s earlier, and slightly more helpful, Enterprise Finance Guarantee Scheme (EFG), which is still in place. But while the EFG is better than the new scheme, it’s still not as helpful as it might be, and there’s a huge amount of Government spin and press misreporting around this area.
So what’s the difference between these schemes and how is it best to proceed in order to raise bank finance?

The new National Loan Guarantee Scheme (NLGS)
On the face of it, this sounds good. The scheme aims to help businesses access cheaper finance by reducing the cost of bank loans under the scheme by one percentage point. A business will be eligible to apply for an NLGS loan if it has an annual turnover of less than £50 million.
The loan will be taken out from a participating bank (currently Barclays, Bank of Scotland, Lloyds TSB, NatWest, RBS and Santander), and the discount is available on new-term loans as well as new hire-purchase and leasing agreements. NLGS funding is not available for overdrafts, invoice finance, or for revolving credit facilities or credit cards. The scheme is quite flexible and there is no minimum or maximum amount that businesses can borrow under the scheme – nor is there any fixed repayment term for the borrowing other than the minimum of a one-year term.
The loans are not available to all businesses – the European Commission State Aid rules apply differently to firms in certain industries, including agriculture, fisheries, road freight transport and primary products so companies in these sectors may not qualify. If you are in one of these industries you will need to study the small print.
This scheme works by the Government providing bulk guarantees to the banks to allow them to borrow more cheaply in the wholesale market. The bank pays a fee to the Government and is required to pass on the discount. However, HSBC, which has robust funding of its own and less need for this type of guarantee, has already declined to participate in the scheme saying that it is not commercially viable for it to offer the loans.
The real problem with the scheme is that a saving of one percentage point on borrowing costs is unlikely to help UK SMEs when the problem is access to finance not its cost. Steward Baird, founder of Stone Venture Partners, put it succinctly, saying: “Cheap money will not spark the economy, money in the right places will spark the economy. Instead, companies need finance full stop, not just cheaper finance”. One commentator even described the NLGS as “so irrelevant that the banks had to be arm-twisted into joining”.
Enterprise Finance Guarantee
In theory the Enterprise Finance Guarantee (EFG) – originally introduced by the then Chancellor, Alastair Darling, in March 2009 is better designed to address the supply of finance to SMEs. Under the EFG the Government provides a guarantee for 75% of the loan balances advanced by banks to SMEs in return for a guaranted premium of 2% paid by the borrower. Unlike the macro guarantees provided by the Government to the banks under the new NLGS, these guarantees are loan specific, and the guarantee is linked to the individual borrower’s default.
EFG loans should be provided by the banks to companies that look like a good lending proposition in all respects other than that they are unable to provide adequate security for the loan. So a company without bricks and mortar security or fundable debtors would be an ideal candidate, provided it was profitable, and therefore likely to be able to service the debt. EFG loans are available to businesses with turnover up to £41m, but are restricted to loans between £1,000 and £1m. The EFG can be used to support term loans. On a positive note, unlike NLGS loans the EFG is also available to support borrowing in the form of overdraft and invoice discounting.

The EFG is, in many respects, like a turbo-charged version of the old Small Firms Loan Guarantee Scheme. Introduced in 1981, this was a much more limited scheme providing 75% guarantees on loans of up to £250,000 and for businesses with turnover up to £5.6m. It was also quite restrictive on the purposes that the loan money could be used for. In 2007 the total loans under the scheme were only £207m.
So far so good. Like its predecessor, SFLGS, the EFG aims to support provision of loans that would otherwise not be advanced to businesses that are viable but have limited track records and collateral. So on the face of it, Alastair Darling’s effort beats George Osborne’s hands down.
However, it’s not as good as it sounds. The 75% guarantee is available to the banks on an individual loan basis but – and it’s a big but – the guarantee is only provided up to 9.75% of the banks’ EFG debt portfolio. So, if a single loan of £100,000 were to go bad, the Government would meet 75% of it or £75,000. This means that if a portfolio of ten £100,000 loans were to go bad, the maximum the Government would meet would be £97,500 or 9.75% of the portfolio. Of course, this should more than cover the bad debts to be expected from sensible lending activity.
So don’t be too hard on the banks if it looks like they are rather less gung-ho about lending than you would expect from someone with a 75% Government guarantee. In reality it’s a 9.75% guarantee cleverly spun by the Government as a 75% guarantee.
How to source borrowing
It cannot be good for business or for ‘UK plc’ that viable businesses have their growth constrained through lack of funds for expansion. But the reality is that bad lending proposals will struggle to get funded, and as shareholders in the banks – via the Government or via our pension funds – we should be glad.
At the other end of the spectrum, we know from experience that really good proposals will induce a feeding frenzy amongst lenders. In the middle, reasonably good lending proposals sadly stand a good chance of not succeeding unless they are well presented, and this means selling it to the bank in terms they can understand, but not overselling it either.
Beyond that, the chances of success are greatly increased if you can approach an individual banker with a track record of succeeding in getting lending deals done within their organisation. It’s probably worth teaming up with an advisor who will know the best bankers to approach, can help you present the opportunity in the best light, and lend their own personal credibility with the bank to help oil the wheels.  

Finally, don’t rely on one bank to deliver. You do need to spread a safety net and talk to more than one bank in case your preferred candidate fails to deliver. However, don’t talk to too many – you’ll use up your valuable time managing them, and it’s only fair to give those you’re working with a fair chance of your business. It takes a considerable amount of effort to get credit approval for a loan, and bankers will be reluctant to put that time in for you if it’s pretty clear that you’ve touted the deal to everyone in town.

The way forward…
In summary, beware of snake-oil salesmen and Government ministers peddling loan schemes to help SMEs. Work up a solid banking proposition, and get help in presenting to the bankers who are most likely to deliver for you. If your proposition is just not bankable – accept that reality and raise equity finance, which is a whole new topic in itself. Alternatively, go to work on your business model instead and see if you can do things differently or change your business to make it more bankable.