Banks under pressure to focus on SMEs

‘There’s no shortage of funds available to the SME market’ – Gary Palmer, CEO – Paragon Lending.

MELITTA NGALONKULU: … Many entrepreneurs spend a lot of time trying to find funding and they are not always successful. If you are an entrepreneur that is always running around looking for funding and getting rejected, or perhaps you are planning to expand your business but funds are limited, you might just want to lend us your ear for a few minutes.

Today we have Gary Palmer, CEO of Paragon Lending, to speak to us about being better prepared when looking for funding. Paragon is a private lending company that specialises in providing debt solutions for companies or individuals. Hi Gary, welcome to the show.

GARY PALMER: Thanks very much.

MELITTA NGALONKULU: So what gets SMEs (small and medium-sized enterprises) into panic mode when it comes to looking for funding?

GARY PALMER: I think the starting point is that a lot of the SMEs are by nature entrepreneurs, so they are particularly good at understanding their product and their market, but often forget about how you finance the business going forward. So a lot of these SMEs are intimidated when it comes to funding. They believe, and correctly so, it actually is a specialist skill in looking for funding. Where do you go? And then once you’ve arrived what do you ask for? So it is an intimidating experience, but if you can get the funding right from the beginning as an SME, it will be critical to the success of your business.

MELITTA NGALONKULU: How do you go about building a relationship with funders?

GARY PALMER: I think the starting point is to know that there are a lot of funders out in South Africa. People are under the misconception that unless you are dealing with the ‘big four’ banks, maybe some smaller lenders, then you’ve got no chance of obtaining funding. So I would say the starting point is just the knowledge of the fact that South Africa has got a huge number of lenders, being the big banks, the small banks, asset managers, DFIs (development finance institutions), private lenders as well. So there’s no shortage of funding in South Africa. In terms of the introduction of, which we’ll speak about later, fintech companies as well, there’s a huge emergence of fintech companies. So there’s no shortage of funds available to the SME market.

Top reason for SME failure is incorrect funding  

MELITTA NGALONKULU: How does a business or an entrepreneur basically set their long- and short-term goals when it comes to funding?

GARY PALMER: The starting point is where you go to obtain the funding. There are specialists in the market that are orginators as well. … Paragon … provides funding ourselves but if it doesn’t fit in our market, we’ve got access to about 115 lenders in South Africa. So people approach us, we’ve got the skills to understand the deal, potentially create the business model and potentially go into the market to raise the funding for them. So the SMEs mustn’t feel the pressure of feeling that they need to know all of this information themselves in terms of business models and where to go – there are specialists in the market. So I think the starting point is to identify who the players are in the market and who can assist them, even if it’s their accountant, their auditors, maybe some attorneys, family, friends, to ask around for people’s experience and eventually they will find maybe the right funding partner in the market or an originator who will help them assess who the right lenders are.

In terms of short-term and long-term goals, I think when you are an SME starting out, obviously there’s this survival mode, like a lot of businesses unfortunately don’t succeed.

If you look at the five main reasons for failure of SMEs, on top of the list is the incorrect funding, they don’t have the funding or the wrong funding for them.

So that’s assuming that they’ve identified the market and the market wants their product. That’s the number one actually, number two is the funding. So they need to from the beginning sit down with somebody who can assist them with building a one-year projection, if they’re a new business, and they can expand to a five-year business model, and you can assess in that what type of funding is required, because there’s nothing better than if you are a funder and somebody approaches you and they actually know what they are looking for, as opposed to [being] a little bit unclear as to what they are looking for. So to spend time with a specialist, either an accountant or a banker, somebody to assist them with the modeling of their business and their forecast and their working capital requirements is critical.

MELITTA NGALONKULU: How would you advise them to keep their books attractive so that they may be able to receive funding?

GARY PALMER: It’s critical, besides for their own business, to have monthly accounts that are up to date. I have seen businesses approach us and they are a year out of date with their financial statements. Now, nobody can really help them with that, especially, I would say, about five or six years ago when it was really only the banks that were playing in this market, unless your financials were up to date, nobody could help you. Things have changed slightly in respect of the emergence of a lot of these fintech lenders in the market. At present, after I did a bit of reading, I think there are 28 fintech lending companies in South Africa, of which nine focus on SMEs. Now, the model has completely been flipped on its head, whereby a lot of SMEs – I’m talking about in the main streets, you’ve got café’s and the like –how do they get funding?

The model has changed whereby a lot of these fintech companies are actually just looking at their turnover, their credit card swipes, they’re actually not looking necessarily at their detailed financial statements. This is quite new.

So I would say just to have good governance in the business, to understand exactly where you are in the business you need up-to-date financial statements. You also must ensure, and this is critical, that people are paying their tax on time.

I’ve heard too many stories where they are behind in their tax and so then there is no way of getting funding. You can’t get bridging funding, the banks are not going to lend to you. So people tend to ignore the tax component and considering South Africa specifically, Sars has been battling to hit their targets. Sars has become a lot more proactive in trying to make sure they are collecting tax and they are going to start as well with the SMEs. So it’s critical that the financial statements are up to date.

MELITTA NGALONKULU: Gary, would you say it’s conducive for an entrepreneur to keep going to the same lender as a way of reducing their rates?

GARY PALMER: Definitely not, I think it’s a risk. Again, in the old days you used to have a bank manager and you relied on that one bank manager to take care of all of your affairs. The lending landscape in South Africa has become exceptionally competitive, even among the banks (but I’m talking about the new banks that are coming on the scene now). There are also a lot of non-bank lenders in the market, a lot. Now, what you are going to find probably this year and going forward, especially when it comes to SMEs, there’s a term called ‘impact funding’. Now, I would say the last three years has been dominated by fintech and I think going forward you are still going to have fintech, but you’re going to have impact funding being spoken about a lot.

Impact funding is those funds that are coming into South Africa specifically to support entrepreneurs and SMEs. I believe that banks now and other lenders are under pressure to focus on the SME market, so that’s good news for SMEs, that there is no shortage of funding. If anything, there’s a lot of pressure for banks and for overseas players to come in and fund SMEs. So there’s a lot of money around.

I wouldn’t suggest that one only deals with their bank, one bank, because there is so much competition around. I believe you can do better in terms of pricing.

When we go out raising funding for clients, sometimes we run a closed tender process with all the institutions to make sure we’re getting the best deal. I would open it up to a few lenders. I think you are also derisking yourself that if one lender has a change of appetite or attitude towards a specific sector, you’re not collateral damage. Now, if you’ve got relationships with a few lenders in the market, it can only be to the entrepreneur’s benefit.

Evaluating cash flow to ensure debt can be serviced

MELITTA NGALONKULU: So would you not say that they are putting themselves at risk of over-exposing themselves?

GARY PALMER: The important thing is one has to look at the overall debt position, because if you owe a R1 million to one bank or you owe R500 000 to two banks, you have to look at the overall position of your business, how much can you sustain in terms of debt. So I would [not] look at, whether it’s one bank or you’ve spread it among four banks. I would just look at the consolidated picture and say that if I owe R1 million in total, perhaps I am overexposed to all the banks and all the lenders. So I would not concentrate on how much money I owe one particular bank necessarily, but I’d have a look at my assets. I’d have a look at my liability but, most importantly, I’d have a look at my cash flow going forward to make sure that I can service the debt. That’s a critical exercise because the banks or other funders are going to say can you service the debt?

When you are an entrepreneur running an SME often there is no security, so you have to really rely on your cash flow and you’ve got to see how much gearing or debt can I get and how much income is coming in to service that particular debt. So that’s a very important area to focus on because the minute you go into arrears and it affects your credit scoring, it’s going to affect all the banks that are lending to you.

Five tips for finding finance

MELITTA NGALONKULU: What are the five main tips that you would give to an entrepreneur looking for financing?

GARY PALMER: The starting point is suretyships/guarantees. In South Africa we borrow money and we sign surety. I think the term ‘surety’ is gone; it’s now known as a guarantee, so you now are on the hook. So if you are borrowing money, whether it’s a non-bank lender or a bank lender, you are signing personal guarantee that if the business does not succeed, technically you are personally on the hook.

So it’s very important when people are borrowing money to read through that guarantee document and understand what that means. That’s tip number one.

Number two is always look for hidden fees and costs and early settlement fees and so on because when you are an SME you are focusing on your business; the capital raising side is a different skill…. I had a client a while ago and I was going through their financials, and he said, ‘No, it’s quite cheap. I borrowed money from this one non-bank lender.’ So I said to him what effective rate are you paying? He didn’t really understand what I was saying. So he said ‘I’m only paying R20 000, or let’s call it R30 000 a month’. But when I ran the numbers, the effective rate of interest was 50% a year. Some of them phrase it differently with raising fees and some of them have got hidden fees and costs. So that’s tip number two is when you’re getting these terms sheets from the lenders, make sure you understand what the effective rate is that you are paying.

Tip number three is always just ensure that you are borrowing money from a credible source. A lot of these fintech companies and non-bank lenders and so on, a lot of people haven’t heard of them. You’ve just got to make sure that whoever you are borrowing from you understand how they operate, what is their history and, most importantly, where they get their money from. I think if you are borrowing from places where they’ve got an aggressive style of collection or you haven’t heard of them [beware]. You need to be borrowing money from reputable players.

Especially the way it’s working in South Africa at the moment with the emergence of fintech, I would really ask the SMEs and entrepreneurs to ensure that their credit status is always good. Because banks have always lent in a certain way, now with the fintechs lending in a different way, the common factor with both of them is that they do credit checks on all the clients and they are going deeper and deeper now, especially since we are in a recession in South Africa and there are a lot more bad debts. The banks can now even look at your social media, Google checks, Facebook and then do the credit checks, and there’s going to be a deep dive in terms of the individuals behind the deals.

The last point is just make sure the tax is up to date. A lot of people don’t worry about tax, especially in the SME market, and I often get told this is one set of financial statements for you and I’ve got another set of financial statements for the taxman. That can’t happen.

MELITTA NGALONKULU: That was Gary Palmer, CEO of Paragon Lending.

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