SME Lending – The Credit Memorandum
In working closely with SME clients, Business Finance Professionals gain a comprehensive and detailed understanding of their client’s business, operations and plans for the future. They also have knowledge and insights into how lenders approach credit analysis and loan applications.
As such, when the time comes for a SME to expand and grow, or they need funding to get them over a hurdle, Business Finance Professionals have a unique and important role to play. And the tool that places the SME’s lending needs in front of the appropriate lenders is the Credit Memorandum.
A credit memorandum is the primary means of communications within the finance industry. Whilst lenders may have their own templates and have internal processes and policies for the use of the credit memorandum, a good understanding of how to effectively document the information that a credit memorandum conveys can make all the difference.
Many maintain that the credit memorandum is all about the numbers – the facts and figures contained in cash flow reports, balance sheets, profit & loss statements, revenue projections, personal and business credit histories, tax lodgements and bank statements. And certainly, a solid credit memorandum will demonstrate to the lender that your client’s SME is currently in good financial standing. However, an effective credit memorandum goes a step further - they detail and explain why a SME is a good credit risk.
The following six areas and tips assist with the format, style, messaging and content of an effective credit memorandum.
1. Risks
It may seem counter-intuitive, but one of the very first sections of a credit memorandum should be about risks. Every loan has them, and credit analysts and lenders want to know, upfront, what they are dealing with. There are two important aspects of outlining the risks of the loan.
a) Concentrate on relevant and pertinent risks. Again, in making their decisions, lenders want to ‘cut to the chase’ and drill down to what is important. They don’t care you have tried to consider every possibility and risk that could impact the business. Also, don’t include high-level macro risks that will affect all businesses. Natural disasters and recessions impact everyone’s abilities to repay loans and lenders already understand this. Concentrate on and be specific about your SME’s operations and their risks.
b) For each of the relevant risks you have listed, fully explain those risks and, critically, address how those risks would be mitigated by the SME. This section of your credit memorandum isn’t negatively based; it shows a proactive approach and preparedness to protecting the SME when things go wrong.
Depending on the format of your credit memorandum, it may be, that to be upfront with the risks, you use an executive summary with these as the main points. It all demonstrates that you have analysed the financial facts and figures; interpreted from these the pertinent risks; and considered the ways they can be addressed. In itself, this gives a lender a great sense of the quality of the SME.
2. Persuasion
Remember that a primary role of the Business Finance Professional is to work for the SME and persuade the lender to approve a loan. However, the approach and message in the credit memorandum should be objective in nature. Objective persuasion means considering the risks of the loan from the lender’s perspective and using analysis, reasoning and logic to promote a loan approval. Persuasion can get lost when it is seen as biased, simplistic and emotive in its messaging.
The use of positive words and phrases can influence the reader of the credit memorandum. In fact, a study across a wide variety of credit memoranda noted that successful submissions had around five to ten percent more positive words than negative.
3. Lenders Format
As mentioned, lenders have their own preferred formats and structures for credit memoranda, basically for consistency in their internal communications. Layouts differ and some are better than others, however, adapting your credit memorandum submission to match, or closely equate, to their format can help. A different format can confuse the reader and they may miss reviewing important information because it is not where they expect it to be. It also takes the credit analyst more time (it is suggested up to 20 minutes) to review a credit memorandum that, for them, is in a non-standard format.
All of this can reduce the chances of loan approval. So, taking the time to adapt your credit memorandum to fit different lender’s format can be advantageous to your SME client.
As a Business finance Professional, one of the greatest assets you can bring to the process is your relationship with the lender. Getting to know their processes and the best format to provide information and credit memoranda to them can be invaluable. And actually meeting or having a conversation with the individual(s) who will be handling and reading the credit memoranda you present, opens up healthy communication channels.
4. Clear, Concise and Simple
Credit memoranda are not the opportunity to show off your extensive vocabulary and narrative skills. Being clear and concise means choosing words carefully and saying what you mean in the most simplistic manner. Less is more. Consider that the reader is time-poor and will appreciate dot points, highlighted key elements and an overall structure that helps them find the information they need easily.
Use facts instead of descriptive words. For example, instead of saying ‘a substantial decline in revenue’, say ‘revenue was off 17%’. Also, avoid jargon. Credit analysts will probably not be experts in your SME client’s industry, and words or phrases that are industry-specific may be misconstrued.
The objective is to present a credit memorandum that is as short in length as possible while providing all the necessary information and explanation.
The use of appendixes and supporting materials can be quite helpful in achieving this objective. By adding things like financial modelling and credit reports in an appendix, you provide the option for both high-level reviews (some analysts will be able to make a decision based on the body of the credit memorandum) and detailed analysis (other credit analysts will want to review the minutia of the credit memorandum as provided in the appendix). This approach also recognises that different personnel within the lending firm or institution may be part of the loan approval process and have different needs in relation to their role.
5. Financial Analysis
Whether they are in the appendix or the body of your credit memorandum, the SME’s financials are obviously going to play an important part in the credit analysis. There are many types of financials that can be presented, including the Balance Sheet, Profit and Loss Statement, Cash flow Statement, Ratio Analysis and Financial Forecasts and Projections.
Again, the key is to select the most appropriate inclusions and, within them, highlight and explain the pertinent and relevant factors.
6. Management Analysis
As imperative as the financials are, it is important to note that most lenders spend more time analysing the management structure of the SME. Because the financials provide a clear black or white numerical outcome, they need to be supported by and coupled with additional inputs. Management analysis is an important overlay that provides a point of distinction and can be the potential deciding factor for loan approval.
For small loans or lending that is backed by collateral, management analysis becomes even more relevant.
When writing a credit memorandum, Business Finance Professionals should take the time to explain why the SME management structure and management team is a key aspect of risk mitigation and ensuring loan repayments will be made.
Credit Memoranda come in all ‘shapes and sizes’, although they all have a common purpose – they are a key ingredient in the lending process and the mechanism to convey the SME’s borrowing needs for assessment against the lender's criteria.
Business Finance Professionals who hone their skills and apply the appropriate format, style and content inclusions when writing credit memoranda are integral in generating compelling and effective lending applications for their SME clients.
In conjunction with industry experts, elevateB has developed a self-paced, online, interactive Business Finance Certification. This program will provide you with the knowledge and skills required to become a successful Business Finance Professional and work in the SME space. In addition, it provides strategies and soft skills to assist you to better market and deliver your existing and new-found client offerings.
For more information on the Business Finance Certification, click here.