SMEs need to improve the quality and transparency of data they provide financial institutions when applying for loans, writes SIMON NGAN

Cries from small- and medium-sized enterprises (SMEs) that they continue to face problems raising capital are generally taken with a generous pinch of scepticism. But the plight of SMEs looking for finance was brought home in October when media reports following a police raid on a loan-sharking syndicate revealed that half of the 200 debtors who took out loans were SMEs.

The willingness to borrow at interest rates of up to 430 per cent a year is perhaps indicative of the dire financial circumstances under which these businesses operated. After all, why would any owner-operator of sound mind and reason pay such usurious rates when he or she has the option of borrowing from banks?

SMEs say they often have little choice, but how legitimate are such complaints?

A wide array of loans are offered to SMEs to meet their short- to long-term needs, but many small businesses are unable to access these funds. According to K K Yeung, chairman of the Chamber's SME Committee, there are many conditions that a company needs to meet before they qualify for a loan and often these include the requirement for putting up security.

"Banks are after all running a business and they need to hedge against possible risks when lending out money," he said.

Gerry Ma, CEO of SME Finance, says that although collateral is important, lending institutions also take into account a company's track record -- such as its cash flow and sales turnover.

"The issue that many SMEs face when applying for non-collateral financing is in the quality of the information that they provide to banks," he said. Often times, financial data furnished fall short of that required. "How can banks make decisions when most of the time records submitted are incomplete, disorganised, or questionable?" asked Mr Ma.

Without this information, entrepreneurs' only recourse in securing loans is with collateral, or going to less conventional and unregulated sources.

For Benson Pau, managing director of Wings Trading, the issue of borrowing is not so much about a business' collateral than its prospects. "Unless you are a start-up with no track record to speak of or you are in an industry whose outlook is regarded to be deteriorating, collateral isn't really an issue with banks," he said.

For sure, both lenders and borrowers underwent a steep learning curve following the bursting of the property bubble. During the heydays financing was simple and straight-forward. Of the three "C's" of lending -- collateral, cash flow and character or credibility -- the latter two were conveniently neglected.

"The substantial decline in property values means that businesses have had to work even harder to prove their creditworthiness," Mr Ma said.

This is especially difficult for many small companies whose owners are at the same time responsible for sales, accounting, administration, human resources and other facets of running a business.

"Given this scenario, how can one expect such companies to deliver concise, accurate and credible financial information that goes back many months or years?" he asks.

Unfortunately, this has given rise to the perception that banks are turning their backs against small businesses, a criticism that Mr Ma feels is unfair.

"Banks are increasingly catering to the needs of SMEs and you see this in terms of more and more specialised lending units being set up."

Before these units came along, said Ma, entrepreneurs had to deal with bankers who had little experience with SMEs.

"Banks have also become more flexible in providing loans that differ in size -- anywhere from a hundred thousand to several millions of dollars," he said.

Although SMEs have always had beefs about banks' demands for collateral, their complaints may take not take into account hidden costs that the latter incur on defaulted loans, Mr Ma said. For example, there is a period of time between the default and the realisation of the security when the bank receives nothing.

"There are also extra costs of deploying manpower and resources to oversee the disposal of the assets offered for collateral," he said. In addition, liquidating collateral such as specialised equipment often means a longer period of negative cash flow for banks, which could potentially chip away at the real value of the asset.

Banks' greater attention to SME customers has meant the latter are benefiting from better financing deals. "Loans used to made on a prime-plus basis and nowadays these are offered as prime-minus," Mr Yeung said.

While this may be true in the conventional sense, that is, for loans taken out against collateral, non-collateral financing or unsecured loans command relatively higher interest due to the increase in perceived risk. Citing the example of account receivables financing, Mr Ma said, "Borrowers should also be aware of the consequences of opting for such loans, one of which is the difficulty in getting new loans from other banks as there are no more assets to be pledged."

Another factor that businesses should bear in mind with AR financing is that existing credit lines could be reduced, sometimes quite substantially, due to a variety of factors that may be beyond the borrower's control. "Your accounts receivables would be called into question, if say, your shipments are affected by the port lockout in the U.S. West Coast," he said.

However, whether a company qualifies for non-collateral loans in the first place depends significantly on how well it is able to present information on itself in a clear and positive light.

"My advice to SMEs is to improve their communication capabilities with banks if they want a better chance of being given a loan," Mr Yeung said. "They should be able to tell banks that they are capable of repaying loans, service debt and have in place sound financial systems. The importance of qualitative and quantitative information cannot be overstated."

Unlike investment funds, SMEs' future prospects are judged on their past performance. "Without a track record, all bets are off," Mr Yeung said. Or as Mr Pau puts it, "It isn't so much about difficulty in getting loans than being able to show you that have done your homework in terms of being able to explain to bankers where your business is coming from, where you want it to go and how to get there."