by Real Business - Thursday, 30th August 2007

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If you’ve got no cash and no collateral and you can’t raise money on the angel circuit, there’s one last resort: the Small Firms’ Loan Guarantee (SFLG) scheme.

This helps firms aged under five years to borrow up to £250,000, as the DTI will cover 75 per cent of the loan if they should default on their repayments.

The Body Shop, Coffee Republic and Waterstone’s all started with a loan under the SFLG, which has been running since 1981. But the scheme has gained something of a bad reputation. Thousands of startups apply for a loan each year, only to be turned down. Even those that are successful complain about the tortuous application procedure. In fact, since the rules were tightened in December 2005, the amount of money being lent has fallen by half. It’s never been harder to secure an SFLG-backed loan.

Entrepreneur Sam Hurst can tell you all about the problems associated with the SFLG. His plan to open a chain of roast-meats sandwich shops called Grazing was reported in Real Business in October 2005. We thought he was on to a winner and the experienced tycoons he spoke to, such as Martyn Dawes of Coffee Nation, told him that he’d have no problem finding funding.

“I spoke to all the high-street lenders about getting an SFLG backed loan,” Hurst recalls. “The bank managers would all tell me that they loved my plan and they assured me that I would have no problem getting my application approved. Yet their credit committees turned me down every time.”

Hurst applied to Allied Irish Bank, Bank of Scotland Barclays, Clydesdale, HSBC, NatWest and RBS. “It was demoralising. I made the mistake of not applying simultaneously and each application took three to four weeks,” he says.

Hurst was also surprised at the banks’ lack of expertise. “At HSBC I spoke to someone who looked about 15 years old. At Barclays I had to spend ages hunting down the guy who knew about the SFLG. At Bank of Scotland I had to talk to someone at its Edinburgh branch. It was a wild-goose chase.”

But Hurst’s persistence eventually paid off. “When I got turned down by Clydesdale, the guy I was dealing with there said that he had a friend at Lloyds TSB who might be able to help me. So I contacted Lloyds TSB and got my loan with their guidance,” he says.

Initially he wanted the maximum £250,000, but after each rejection he lowered his sights until he eventually trousered only £85,000. “Borrowing less means that I’ve had to cut a lot out of my business plan,” Hurst says. “But maybe that’s a good thing.” A year and a half after starting his quest for funding he is now about to open his first outlet. “My advice? Keep trying,” he says.

Draft excluders

Hurst’s experience is depressingly typical. To avoid a similar run-around, many entrepreneurs are turning to specialist consultants. Dave Rich, of Strategy Consulting, often works on applications that have been rejected.

“When an entrepreneur shows me their business plan, it almost always needs to be rewritten,” he says.

“Some are too long. They should be between ten and 15 pages. If you’re sending reams of paper to the banks you’re in danger of boring them. They don’t want a technical treatise.”

Everything in your business plan should focus on showing how you will pay the money back, according to Rich. “Banks need to see the right financial information. This means they’ll want month-by-month cash flow breakdowns for the first two years,” he says. “If you are pre-revenue, you’ll need to provide evidence that someone is going to buy your product. Banks don’t want technical mumbo-jumbo. They want to see contracts with buyers.”

Rich points out that applications for capital investments are much more likely to succeed. “The bank will want to know what you are going to spend the loan money on. What are you going to achieve with it? It’s no good simply spending it on salaries and rent.” Intangibles matter, too. “You will need to convince the bank that you have the right management experience, Rich says. “Who will be taking care of the numbers? You’ll need an experienced FD or an accountant who’s prepared to work closely with you.”

When you’ve got a polished application, a consultant can help you deliver it to the right person. “It’s got to go to a business development manager who understands your sector,” Rich stresses. “For goodness’ sake, don’t give it to your local branch manager, who has no influence with the credit committee.

The right person will understand your plan and they will be able to influence their credit committee. Personal politics play a surprisingly large role here.”

Timing the application is also crucial. “Banks have strict targets. If a bank has lent too much money in a quarter, or it has had its fingers burned in a particular sector, then we might send a proposal to a more receptive institution,” Rich says. “We can stop entrepreneurs wasting their time on banks that have no intention of making any more loans for a financial quarter.”

Consultants will want a fee, of course: normally a flat project fee plus a low percentage of funds raised. This figure is competitive, so shop around. Rich puts in a strong pitch for his services, claiming that “only one in four independently submitted applications for an SFLG succeeds. Apply with a consultant and it’s a 95 per cent success rate.”

A consultant can also help you raise other money, which is often necessary, since banks will authorise an SFLG loan only if the amount is matched by other investors.

Richard Constandoros, founder of essential oils producer Highland Natural Products, raised £300,000 in 2004, £80,000 of which came from the SFLG scheme. “We wanted to keep control of the equity, but we had no security. So we sold 28 per cent to the Scottish Enterprise Business Growth Fund, put some money in ourselves and got an SFLG loan,” he explains. “This mix allowed us to retain a large share of the company.”

To co-ordinate the three strands of funding, Constandoros used Beer & Partners, an organisation well known for its expertise at raising cash for start-ups. “We paid Beer & Partners a project fee and a small percentage fee of the money raised – a price well worth paying,” Constandoros says.

Catch on delivery

Even if you do get a loan, watch out. When Kevin Meagher, founder of monitoring and control service provider Intamac, secured £100,000 he was initially delighted. But problems quickly arose.

“When I went back to NatWest for more money, it said I wasn’t applicable for a second round. This was unbelievable, as I had deals flowing through the business,” Meagher says.

“At a networking event I bumped into a guy from Barclays, who was amazed at NatWest’s attitude. After meeting Barclays’ business development manager I got the extra funds and switched my account.”

Alas, more problems surfaced. “What banks don’t tell you is that an SFLG loan counts as state aid under EU rules, so you can’t then apply for other grants once you’ve got it. I wanted to go for a DTI Smart Award for R&D and an export grant, but we couldn’t apply for either,” he says.

There’s also the minor issue of repayments. “The default rate is 35 per cent,” says Peter Ewen, consultant at Venture Finance. “While this may seem high, only seven or eight out of ten start-ups make it, so it’s actually a very encouraging statistic.”

Under the terms of the SFLG you pay two per cent of the outstanding value of the loan to the DTI, so it makes sense to pay it back swiftly.

“I’m paying £500 a month as a premium,” Hurst says. “That’s pretty steep, but without the SFLG I’d never have got Grazing off the ground. From that perspective it’s a bargain, and I wouldn’t hesitate to recommend the scheme to other entrepreneurs.”

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