Richard Kateley, head of specialist protection at Legal & General highlights what you need to look out for when assessing the risk in your business loan
Research released this week revealed the dwindling number of SME bank loans in the UK. According to Funding Options, the drop in loans totals to a value nearing $145 million every month, primarily because of regulatory changes on bank overdrafts.
This underscores the fact that even the most successful businesses are at risk of their overdrafts being cut with almost no notice, a risk that comes from unsecured loans.
Growth Business spoke to Richard Kateley, head of specialist protection at Legal & General on how SMEs can risk-proof their loans and work out a manageable repayment plan.
How can SMEs assess the risks they face when borrowing?
Firstly, business owners must ensure they have an understanding of the loan terms – this should include the guarantees required for repayment. One crucial factor to be aware of is whether or not the repayment will be demanded at short notice if a key person or business owner were to die or be unable to work.
An example of when this is encountered is with Director Loans when a director loans their own money to the business. These terms of these vary but are usually open-ended or on a rolling one year basis. If the director were to die in this instance, the debt would be on demand from the estate. To prevent any difficulties in repayment, it is recommended that the guarantor on a Director Loan is insured for the full amount; in these delicate circumstances, the last thing business owners want to worry about is finding the large sums of cash needed to repay the loans.
Research carried out by Legal & General revealed that a third of UK SMEs have no insurance whatsoever to cover their debts. This is despite the fact that nearly two-thirds of businesses carry some form of debt, with the average SME owing nearly £350,000 at any one time. If anything unexpected were to happen to a key person with regards to illness or death, many SMEs could not only be left struggling to deal with the absence of a vital cog, but they would also need to find the large sum of cash to repay the loan.
Some debts are more risky than others, such as short-term financing in the form of Credit Cards, Overdrafts and Director Loan Accounts, all of which seem to be on the rise. The number of SMEs using credit cards alone has rocketed in four years, from just 3 per cent in 2011 to 23 per cent in 2015. Similarly, SME debts of over £50,000 in Directors Loan Accounts (DLAs) have increased from 20 per cent to 33 per cent. Directors Loan Accounts (DLAs) present a particular risk as fundamental awareness of how they work are not as high as they could be. Nearly a third (28 per cent) of the directors we asked didn’t realise their DLA needed to be repaid in the event of their death.”
What would you say is a strong repayment plan?
As an insurance company, we know of the many risks faced by businesses in everyday life. One of the most common issues owners need to be aware of is the loss of a key person, and what that could do to a business’s finances. A company does not want any loan that they have taken out, for the purpose of promoting business growth, to become a terminal pressure on that very business. It is therefore important that owners address this and have a disaster recovery plan in place for the loan and its repayment, so that they know what will happen if someone key to that loan were to die or no longer be able to work.
What are some of the key issues SMEs need to consider?
“In order to prepare for any unforeseen circumstances, it is crucial that businesses have a disaster plan in place. Owners are recommended to contact an adviser to discuss the specific risks presented to them, so that they are well equipped for what may come.”