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smaller firms。
Bankers like to speak of the ‘five Cs’ of credit analysis； factors they look
at when they evaluate a loan request。 When applying to a bank for a loan；
be prepared to address the following points：
56 The Thirty…Day MBA
。 Character： Bankers lend money to borrowers who appear honest
and who have a good credit history。 Before you apply for a loan； it
makes sense to obtain a copy of your credit report and clean up any
problems。
。 Capacity： This is a prediction of the borrower’s ability to repay the loan。
For a new business； bankers look at the business plan。 For an existing
business； bankers consider financial statements and industry trends。
。 Collateral： Bankers generally want a borrower to pledge an asset that
can be sold to pay off the loan if the borrower lacks funds。
。 Capital： Bankers scrutinize a borrower’s net worth； the amount by
which assets exceed debts。
。 Conditions： Whether bankers give a loan can be influenced by the current
economic climate as well as by the amount。
Types of bank funding
Banks usually offer three types of loan：
。 Overdra。。s： Though technically short…term money as they can be called
in at a moment’s notice； these tend to form a part of the permanent
capital of a business； albeit a fluctuating one。
。 Term loans： Offered for set periods。
。 Government…backed loans： These are available to some types of business；
usually small or new ventures； where the banker’s normal criteria
might not be met； but the government would like to encourage the
sector。
Overdrafts
The principal form of short…term bank funding is an overdra。。； secured by
a charge over the assets of the business。 A li。。le over a quarter of all bank
finance for small firms is in the form of an overdra。。。 If you are starting
out in a contract cleaning business； say； with a major contract； you need
sufficient funds initially to buy the mop and bucket。 Three months into the
contract they will have been paid for； and so there is no point in ge。。ing a
five…year bank loan to cover this； as within a year you will have cash in the
bank and a loan with an early redemption penalty！
However； if your bank account does not get out of the red at any stage
during the year； you will need to re…examine your financing。 All too o。。en
panies utilize an overdra。。 to acquire long…term assets； and that overdra
。。 never seems to disappear； eventually constraining the business。
The a。。raction of overdra。。s is that they are very easy to arrange and take
li。。le time to set up。 That is also their inherent weakness。 The key words in
the arrangement document are ‘repayable on demand’； which leaves the
bank free to make and change the rules as it sees fit。 （This term is under
Finance 57
constant review； and some banks may remove it from the arrangement。）
With other forms of borrowing； as long as you stick to the terms and conditions；
the loan is yours for the duration。 It is not so with overdra。。s。
Term loans
Term loans； as long…term bank borrowings are generally known； are funds
provided by a bank for a number of years。
The interest can either be variable； changing with general interest rates；
or fixed for a number of years ahead。 The proportion of fixed…rate loans
has increased from a third of all term loans to around one in two。 In some
cases it may be possible to move between having a fixed interest rate
and a variable one at certain intervals。 It may even be possible to have a
moratorium on interest payments for a short period； to give the business
some breathing space。 Provided the conditions of the loan are met in such
ma。。ers as repayment； interest and security cover； the money is available
for the period of the loan。 Unlike in the case of an overdra。。； the bank
cannot pull the rug from under you if circumstances （or the local manager）
change。
Just over a third of all term loans are for periods greater than 10 years；
and a quarter are for 3 years or less。
Government Small Firm Loan Guarantee Schemes
These are operated by banks at the instigation of governments in the UK；
and in Australia； the United States and elsewhere。 These schemes guarantee
loans from banks and other financial institutions for small businesses with
viable business proposals that have tried and failed to obtain a conventional
loan because of a lack of security。 Loans are available for periods between 2
and 10 years on sums from ￡5；000 to ￡2；500；000。
The government guarantees 70–90 per cent of the loan。 In return for the
guarantee； the borrower pays a premium of 1–2 per cent per year on the
outstanding amount of the loan。 The mercial aspects of the loan are
ma。。ers between the borrower and the lender。
BONDS； DEBENTURES AND MORTGAGES
Bonds； debentures and mortgages are all kinds of borrowing with different
rights and obligations for the parties concerned。 For a business a mortgage
is much the same as for an individual。 The loan is for a specific event； buying
a particular property asset such as a factory； office or warehouse。 Interest
is payable and the loan itself is secured against the property； so should the
business fail the mortgage can substantially be redeemed。
panies wanting to raise funds for general business purposes； rather
than as with a mortgage where a particular property is being bought； issue
58 The Thirty…Day MBA
debentures or bonds。 These run for a number of years； typically three years
and upwards； with the bond or debenture holder receiving interest over
the life of the loan with the capital returned at the end of the period。
The key difference between debentures and bonds lies in their security
and ranking。 Debentures are unsecured and so in the event of the pany
being unable to pay interest or repay loans they may well get li。。le or
nothing back。 Bonds are secured against specific assets and so rank ahead
of debentures for any payout。
Unlike bank loans； which are usually held by the issuing bank； though
even that assumption is being challenged by the escalation of securitization
of debt being packaged up and sold on； bonds and debentures are sold to
the public in much the same way as shares。 The interest demanded will be
a factor of the prevailing market conditions and the financial strength of the
borrower。
Categories of bond
There are several general categories of bond that panies can tap into：
。 Standard bonds pay interest； a coupon； half…yearly on the principal
amount； known as the face or par value。 At the maturity date the principal
is repaid。 The value of bonds fluctuates dependent on market
conditions； the length of time to maturity and the likelihood of the
borrower defaulting。 None of these ma。。ers are of immediate concern
to the recipient of the funds； as long as they can service the interest。 The
risk is for the bondholder who can see the value of their investment
alter over time。
。 Zero coupon bonds pay no interest over their life but pay a lump sum
at maturity equivalent to the value of the interest such an investment
would normally bear。 The buyer of the bond receives a return by the
gradual appreciation of the bond’s price in the marketplace。 This could
be an a。。ractive financing strategy for a business making an investment
which itself will not bear fruit for a number of years。
。 Junk bonds are bonds usually subordinated to； that is； put below others
in the pecking order of who gets paid in tough times； other regular
bonds。 Such bonds carry a higher interest burden。
。 Callable bonds are used when an issuer wants to retain the option
to buy back their bonds from the public if general interest rates fall
sharply a。。er the issue date。 The issuer notifies bondholders that a。。er
a certain date no further interest will be paid； leaving the holders with
no reason to keep the bond。 The pany issuing the bond can then go
out to the market and launch a new bond at a lower rate of interest and
so lower its cost of capital。 This process is also known as refinancing。
Finance 59
ASSET…BACKED FINANCIERS
The banks are more covert when it es to looking for security for money
lent。 Two other major sources of