Caribbean SME Symposium

What Problems Require Innovative Lending Technologies?

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John Miller Copyright © 2010

The Problems – The Solutions!

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Introduction

• Definition of Lending Technology• Lending technologies employed• The story of one company and it’s

encounters with current lending technologies

• Summary of problems that need innovative solutions

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Definition of Lending TechnologyBerger & Udell 2006 “We define a lending technology as a

unique combination of:• primary information• source screening• underwriting policies/procedures, • loan contract structure• monitoring strategies/mechanisms “

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• Transaction based lending−Financial statement lending−Small business credit scoring−Asset based lending(floating assets)−Factoring−Fixed asset lending−Leasing

• Relationship based lending−Relies on soft information gathered by the

loans officer• Trade Credit

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Lending technologies

Categorisation of Borrowers• Transparent borrowers –

where hard information is readily available

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Categorisation of Borrowers• Opaque Borrowers

– where hard information is difficult to come by

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Lending Technologies Employed in the Caribbean• In practice the majority of borrowers fall

in between transparent and opaque• Lending technologies employed tend to

be a mix of transaction based(financial statement, asset and fixed asset lending) and relationship based lending

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Problems with Relationship Lending• Relationship lending

works for small loans within loans officers’ discretion but the soft information degrades the further the decision maker is from the borrower

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Problems with Transaction Lending• Despite the fact

that floating assets may form a significant proportion of a business’s assets banks tend to focus on the value of fixed assets when assessing collateral

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The story of one company• Spring water bottling company• Started in 1994 by an eminent surgeon who owned the estate on which the

spring stood• Personal and business assets co-mingled with personal assets supporting

credit lines with various banks• Compilations instead of audited accounts• Some profitable years• Owner died in 2004, estate still being settled• Business left to four children three of whom are Doctors and one in university• Elder son (MD, MBA) gave up a career in venture capital in London to assist

his ailing father with the business• I and another local businessman were invited by the owner, when he knew

that he was dying, to join the board

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Problem No 1• In late 2005 I was approached by the MD to assist with a problem

which they were having with their accounts receivable• Problem stemmed from a much more fundamental problem with

their whole accounting system• Two years previously Peachtree for Manufacturing had been

installed free of charge as their accounting programme by a consultant working under a USAID funded programme for OECS manufacturing companies

• The consultant was an IT specialist and not an accountant• The system was set up in isolation and not integrated into the

whole accounting process. • Default settings were left in place that allowed anyone to create

credit accounts with high limits

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Solution to Problem No 1• I directed them to a bookkeeper who

was well versed in electronic accounting systems and who could give them three days a week of his time

• He is still with the company and has progressively given them more time as the business has grown

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Lessons Learned• Short term consulting interventions can sometimes do more

harm than good• There is a need for long term consulting support, possibly on a

shared cost basis• In an international study undertaken by the Institute of Chartered

and Certified Accountants of the UK it was noted that Accountants, lawyers and banks are the most frequently used sources of advice

• SMEs’ use of advisers is correlated to the size of their business, with 75% of the largest SMEs seeking advice compared with 43% of the smallest

• Government and public agencies are ranked lowest as a source of advice; explanations for this included lack of expertise, trust and commitment.

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Problem No 2• I was called in again in late 2006 because

the company was sustaining heavy losses• Thanks to the now transparent accounting

systems it was apparent that their gross margins were declining at an alarming rate

• Problems were traced to low productivity resulting from failures in supply chain and personnel management and inventory leakage due to non existent physical controls

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Solution to Problem No 2• The solution was the same as that

for Problem No 1, long term consulting support, this time supplied by me

• We managed our way back into profitability albeit with numerous constraints, mostly financial

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Lessons Learned• There is a need for a pool of medium

to long term consultants with hands on experience of running businesses in general or with industry specific skills

• Properly functioning accounting systems are critical to the diagnosis and solution of problems within SMEs

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Problem No 3• Because of co-mingling the company’s fixed

assets were mostly in the name of the owner• Despite a growing business we could not

approach the bank for additional working capital finance because our credit lines were frozen at the amount of the debt guaranteed at the owners death and supported by his personal assets

• The bank had no mechanisms in place to provide us with financing against our inventory and receivables

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Solutions to Problem No 3• We leaned on our suppliers for more trade credit• We put two people full time on collecting

receivables• These were only partial fixes, the problem

remains largely unresolved• In the long term the estate will be settled and

company assets transferred to the company. We may then be able to increase borrowings based on our ability to offer more fixed asset security

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Solutions that we would like to have seen to Problem No 3• The ability to access revolving lines

of credit based on the fluctuating values of our inventory

• The ability to factor our receivables based on dynamic values and relative ages

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Problem No 4• Our fleet of delivery trucks and vans have

progressively died on us one after the other

• We are incurring high weekly costs for contract trucks

• Additional loans from our bank will require a full review of our account and will take time

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Solution to Problem No 4• The solution created another problem but

could not be avoided• After missing several opportunities to buy

good replacement vehicles because appropriate credit lines were not in place we eventually resorted to using current cash flows

• We are now seeking refinancing through a non bank financial institution that will finance used commercial vehicles on reasonable terms

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The solution we would like to have seen to Problem No 4• The ability to obtain fast lease

finance for commercial vehicles

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Problem No 5• We need to spend substantial sums

in upgrading and automating our plant

• We need to establish our product in export markets

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Solutions to Problem No 5• We are negotiating with a large regional

beverage company to take an equity interest in the company

• The investment will be both financial and strategic. We will be able to leverage long term capital financing off the new equity and we will have assured access to regional markets

• If for any reason we are unsuccessful with the current negotiations then we will have to find a straight equity partner.

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The solution we would like to have seen to Problem No 5• The strategic investor is in fact our preferred

solution but leaves us with limited options if we are unsuccessful in arriving at a deal

• As an option we would like to see a pool of capital for successful SMEs. Possibly a fund guaranteed by a mix of regional governments and international aid organisations which would make the fund investment grade and attractive to financial institutions

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Summary of SME needs• A means of preventing the degradation of soft

information in the credit decision making process. Possibly a form of credit scoring that quantifies this information

• Appropriate assistance to ensure that SMEs have functioning accounting systems

• A pool of medium to long term advisors with practical hands on business experience

• Responsive and self securing systems for the financing of assets such as inventory and receivables

• Lease financing for vehicles and equipment• A pool of equity financing for successful SMEs

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