How to Get A Loan Without Collateral? This is the challenge Daniel, who is based in Lusaka Zambia faces. He intends to start an advertising and marketing company by the end of the year. He plans to expand and grow his business to a market share of up to 3%. Daniel lacks the finances to get machinery and equipment to start his business. He wants to understand what kind of assets he needs to have for him to raise capital.
Mr. Isililo Mzyece, the Chief Credit Officer from Cavmont Bank Zambia with over 17 years’ in the financial services industry particularly in the areas of sales, operations, and credit risk management provides insights on this challenge.
What is collateral and how does it relate to financing?
Collateral is the assurance that the funder or banker would want to have as a secondary source of repayment if the deal fails or the customer fails to make a repayment of the loan that they have obtained. The collateral may come in the form of;
- A mortgage, a legal mortgage
where a property has been pledged and registered to be in the name of a customer and the creditor or the banker is the mortgagee.
You will be surprised that people offer cash as collateral so that if that loan defaults the banker or the lender can go and access those funds.
- Treasury bills or government bonds
- Business Assets
This could be equipment that you’re using to manufacture whatever products that you have. It’s important to register these types of equipment on the Movable Property (Security Interest) Registry System (MPRS) with the Patents and Companies Registration Agency (PACRA). The MPRS records all registrations of charges or collaterals created by borrowers to secure credits provided by lenders.
Interestingly, Danielle has gone straight to asking about whether he can finance his business with the collateral that he has. Is this the most important question he should be asking himself as a startup?
The most important question that Daniel should be thinking of as a start-up is how his idea will add value to his prospective customers. He should then start using different models to translate that idea into cash flow. Cash flow is the income generated from the business idea. When he takes into consideration whatever expenses he has incurred in implementing his idea, he then remains with net cash flow or operating cash flow.
The net cash flow is what is used to determine if he has the repayment ability to service whatever loan facility that his lender or banker may give him.
The business idea and cash flow are the primary determinants of the source of repayment that is considered by banks or venture capitalist. Lenders consider your idea and whether it’s got the potential to bring in enough cash to sustain loan repayments.
Collateral like the one Daniel is talking about is a secondary source of repayment. Some Lenders may be willing to give a loan facility without collateral, depending on how strong the cash flows are.
What assets qualify to be used as collateral, and how can you determine the value of those assets?
The traditional or conventional collateral that has been used in the market is landed property. This can be a residential property or commercial buildings.
Different collaterals have different Loan to Value (LTVs). This depends on the location and utilization of the property. So for a residential property, you may find that the lender is willing to have a loan to value of 75%, but for commercial property may be at 50%. This thinking is based on how easy it is to dispose of the property in the likely event of default.
Then it could be assets such as vehicles and equipment or even treasury bills. It all depends on what you have. But I must say that sometimes the lender may ask for guarantees. This is where an individual who is the sponsor of a corporate entity gives their personal guarantee that in the likely event that the company fails to pay its debts, they will come in as the individual sponsor to make good whatever outstanding balance on the loan.
Most small businesses cant access finances because they don’t have proper records or financial reports, as a lender, how real is this problem?
The major challenge SMEs are facing is recordkeeping. Recordkeeping is very key in helping a lender to determine the future of the prospects of business such as where it’s going. A good trail or history of two to three years is important. Lenders want to see the cash flows of a business, how good enough the cash is to sustain or repay the loan that has been granted before they give a facility.
So the trend that is built across a two or three years period is very, very key. Audited financial statements are needed. SMEs need to develop the discipline to engage accountants and auditors to prepare those records for them if they want to get loans.
The second issue is to open an account with the bank. Whatever proceeds you are receiving, put them in the bank account. That creates a trail. So when your lender or your banker looks at your requests and forecasts, your story should be clear from your cash flows. A bank account also assists lenders in confirming how realistic your projections are. The lender will consider your history, the account conduct, the credit turnover, whether you have been depositing on a daily or monthly basis, the nature of your business, whether cyclical or not. All this information comes from depositing on the bank account and gives a lender visibility into a borrower’s repayment ability.
The final challenge is putting together a business proposal and detailing how it’s going to happen, what resources you have, your raw material, and what funds you already have reserved. Remember that you also have put in something, no lender is willing and ready to fund 100% of your business. Most lenders want to see that you’ve also put skin in the game.
Lenders also want to see what you have in terms of manpower and skill set. So in the case of Daniel, he needs to demonstrate that he has done this before, and not just going there for the first time. You know, everyone should get that comfort that this business is not speculative, but indeed something is being brought to a table and there is a track record that is proven.
Do you think SMEs need to prepare themselves before they can contact a lender for funds?
SMEs need to formalize things because what you’ve started is a corporate entity that may outlive the individual sponsor. The key thing is to start hiring professionals, Zambia now has many accounting firms that are available at reasonable prices for SMEs to get their books Put in order.
Secondly gets lawyers to advise you from time to time and keep their reports. You never know when you need to make use of them, but that’s always important for the future. If you want to expand the business and enjoy the scale, you will certainly need a lender or financier to support you. So start building that record so that it can speak a Story on your behalf.