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Should your small business take a Covid loan?

Mar 1, 2021

Should your small business take a Covid loan?The Banking Association South Africa recently announced that only R17.84bn of the R200bn Covid-19 Loan Guarantee Scheme for small businesses had been approved by banks.

The scheme received 48 366 applications of which 27% were approved by the banks and taken up by applicants.

According to the Banking Association, while nearly half the applicants did not meet the criteria, many small businesses have elected not to apply as they are reluctant to incur more debt with the future still so uncertain. For those that required working capital, other credit options were preferable.

The idea behind the Covid loan was to offer a guarantee for customers who may not have had collateral for the loans.

Banks must meet the funding requirements set under Basel III which limits the percentage of higher-risk loans they can issue. By National Treasury providing the guarantee, it improved the risk profile of the loan, keeping the interest rate at prime.

While the Covid scheme helped small businesses access capital at a reasonable rate, it still means the business owner must have the ability to repay the loan.

Lending money to a business that is failing and unlikely to recover, would be reckless lending and simply push an entrepreneur into bankruptcy.

Covid loan not always appropriate

Jaco le Roux, head of risk for Relationship Banking in Absa’s Retail and Business Bank, says for many of their customers, the Covid loan was not appropriate.

“We have seen many businesses apply for the Covid loan as a precaution, but have not actually utilised it. Entrepreneurs are clever people, they understand their business environment and remain cautious,” says Le Roux.

“Many businesses will emerge stronger. We have a very resilient business community.”

Although many business clients opted for a structured or bespoke solution, there were also many for whom the Covid loan was a great solution, he adds.

For some business owners however, it made more sense to cut costs, which unfortunately means staff, than commit to more debt in the uncertain environment.

Le Roux says ironically it is only when we see confidence returning and the economic outlook improving that businesses will make more use of the Covid loan facility.

Le Roux says the bank’s approach has been to match the funding with the need, so the first question should always be “what is the problem and therefore what is the need?”

For example, if a small business is in a situation where some debtors have been slow to pay and the businesses needs cashflow until the debtors pay, it is a short-term squeeze. In this case a long-term loan would not be appropriate.

The need may be better met with an overdraft facility. While the interest rate may be higher, it is relatively insignificant over a few months. “You need to keep the loan in line with the liability time frame,” says le Roux.

If, however, there is a situation where a large debtor has gone insolvent and the small business has had to write off a significant portion of what is owed to them, then it is a longer-term problem and the business needs time to pay off that liability, so that may justify a five-year Covid loan.

Le Roux says they have instances where owners need loans to restructure their business, contribute to the purchase of new equipment and stock, and to cover marketing costs, with the ultimate aim to start up their businesses again.

In these cases a Covid loan is appropriate. For example, purchasing new machinery will either lower their long-term operating costs or allow for new products and markets. Asset-backed finance is generally structured over a longer period and the profits are reaped over a longer term.

The business may not have the funds for a deposit due to tough trading conditions, but the machinery will benefit their recovery. In this case the Covid loan may be appropriate to help the business put down a deposit at an attractive interest rate, while allowing the business to generate additional cash.

Kicking the problem down the road

In deciding whether to issue a loan, the banks will also need to decide whether a further loan is going to be beneficial and help tide them over until the business can recover, or whether it is just kicking the problem down the road, leaving the entrepreneur with even more financial stress.

If a business was already struggling before Covid, the best strategy may be for the entrepreneur to close the business and salvage any assets, allowing them to start over again. Trying to fix the problem with more debt may result in the business owner being ruined forever.

The good news is that the bank has seen most of its clients surviving the crisis by adapting quickly.

“One of our clients said he had never realised that he could run his business with so little stock. He has freed up cashflow, and is spending less on warehousing and more on upgrading technology,” says Le Roux.

He adds that Covid has introduced such a shock that those who survive will have learnt important lessons, and often a new way of operating their business.

“Those businesses that survived the late-1990s interest-rate shock survived the 2008 credit crisis. Many businesses will emerge stronger. We have a very resilient business community,” says Le Roux.

Covid loan terms

  • A business may borrow up to six months of operating expenses capped at a maximum loan size of R100 million.
  • Businesses can draw down on the loan over a six-month period and repayments only start six months after the final drawdown. So theoretically repayments could only start in month 13.
  • Any sole proprietor or business can apply, as long as they were in good standing as at 31 December 2019.

This article first appeared in City Press.

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Maya Fisher-French author of Money Questions Answered

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