How to hit the right note for UAE bank loans

As one small business owner found, getting a cash advance for expansion is tricky. But there are some basic issues to address that will help.

The Centre for Musical Arts at the Dubai Gold and Diamonds Park. Victor Besa for The National.
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Securing a bank loan for small businesses is not easy as Tala Badri can testify after starting hers, a music academy, almost 10 years ago.

As a single mother, during the early days of the Centre for Musical Arts (CMA) in Dubai, she had to find a male guarantor to secure a loan to help support the fledgling company. And last year, when she approached three banks for a further Dh2 million loan to expand the business, one rejected her, the second did not bother to respond but the third came up trumps, allowing her to grow the academy.

“I was just lucky that one bank agreed to give me a loan,” Ms Badri says. “I have been trying to expand for the last two to three years and it’s very difficult as an SME to get a bank loan.”

Still, she is happy with the bank that backed her, First Gulf Bank. It looked at her audited accounts and business performance for the past five years, visited the new site of the expansion and studied income. She eventually secured Dh1.2m and the rest was made up with a personal loan she took from the same bank.

In 2006, Ms Badri started the CMA, teaching western orchestral string, woodwind, brass and percussion instruments as well as voice, piano and guitar lessons at Dubai Gold and Diamond Park. With the loan last year, she rented a new 8,000 square feet site at the same location and added a performance theatre, a cafe and a bookstore as well as more studios.

Ms Badri is one of many small business owners who approach banks for loans for expansion. The outcomes are as almost varied as the firms themselves.

While SMEs stand a better chance to secure a loan when they are at an expansion stage rather than the start-up phase, quite a few proposals are rejected. A convincing business plan, cash flow and financial aspects of the expansion plan are the key to winning the loans, according to the banks. These are also among the risk-mitigating steps that banks take while financing SMEs’ expansion plans.

Small businesses comprise 94 per cent of the total number of businesses in the UAE, according to the Khalifa Fund, but banks’ rejection rate for SME lending in the UAE is 50 to 70 per cent, according to a report from the Pinsent Masons law firm in Dubai last year. It did not specify at which stage of an SME the rejection rate applies to.

“A bank will review each SME’s loan application for its individual creditworthiness, as it would with any potential debtor,” says Amir Ahmad, a partner for Pinsent Masons in Dubai.

“Therefore, logically, an SME with a proven track record and a considered business plan for expansion would be more likely to be successful in securing a loan than a start-up.”

Usually the banks finance SMEs with which they have a track record. Among them is Noor Trade, a division of the Sharia-compliant Noor Bank.

“Noor Trade views existing relationships with preference for the obvious reasons that the business performance has already been established, the owners and the management are known and the bank often wins the right of first refusal for the expansion plan,” says Sunando Mukhopadhyay, the head of emerging corporates at Noor Trade.

A proposal from an SME should show the schedule plan of use of the loan, at least two years’ audited financials, and how the expansion will add value to business in terms of market share and financially, says Nilanjan Ray, the managing director of global commercial banking at NBAD in Abu Dhabi.

To reduce risks attached to the loans, the SMEs should also show some collateral.

They are also required to submit financials on a regular basis, say every three months, to gauge the regular receivables besides an inventory ageing report to keep a minimum required net-worth in the company.

Noor Trade looks for the viability of the expansion, future business volumes, break-even analysis and debt service coverage aspects, says Mr Mukhopadhyay.

“We also assess the capability of the contractors, time-frame involved, pay-back period and the debt service coverage capacity of the borrower, always keeping in mind the economic factors prevailing,” he adds. “There are numerous examples of unplanned expansions having failed miserably, leading to dissolution of such companies.”

At NBAD, risk mitigating factors for expansion loans include a mandate for businesses to make direct payments to pre-approved suppliers and contractors involved, such as interior designers, construction companies, and furniture, fixtures and fittings suppliers.

“A small percentage of working capital needs to cover mobilisation and administration expenses during the initial stage of expansion,” Mr Ray says.

Noor Trade prefers to pay the suppliers and contractors of the expansion project directly to ensure that the end use is duly monitored. It also deploys an in-house project expert to regularly evaluate the progress of the project.

Some banks including Noor Trade want to see fixed assets on the ground. Once a loan is approved, the bank relationship teams regularly visit the client to monitor progress and to offer new products and services such as working capital facilities, and banking services to help in their daily transactions.

A lack of tangible assets to provide as collateral, high interest rates, a lack of financial reports as well as equity to partially finance expansion are some of the problems SMEs face.

“The latest research shows the major challenges faced by SMEs are long processing procedures, lengthy administrative steps, excessive fees for processing, high rejection rates of financing requests of between 50 and 57 per cent, unavailability of training establishments providing financial literacy, and marketing training to promote the SME to financial institutions to increase the probability of securing funding,” Mr Ray says.

In most rejected cases the typical reasons include lack of adequate credit history and insufficient cash flow, he adds.

"The biggest issue today with the SME segment in the UAE is that SMEs often do not have proper governance – whether it is financial governance or regulatory compliance, or governance around their business models, or succession planning," Vikas Thapar, the chief executive of Emirates Money at Emirates NBD, told The National in an interview last year. Emirates Money handles SME business of the bank.

Most banks are also wary of lending in sectors deemed high risk due to the high rates of failure. These include hotel apartments, cyber cafes, building materials suppliers, manpower agencies, mobile-phones shops, insurance agents, car rentals companies and small laundries.

Some start-ups, such as now based in Dubai, prefer to turn to venture capital firms and angel investors for expansion loans even if that means they have to part with equity.

“Angel investors are willing to take the risk and if the expansion fails they quit the company and take the losses, but banks tend to claim everything in the company, they are just looking for the interest rates,” says Abdullah Alshalabi, the co-founder of The company works with fishing-boat charter partners across the world who rent out boat for fishing trips.

The company, which is about three years old, is in its third round of fundraising where it expects to raise US$350,000 that will be used for hiring staff, marketing here and in the wider region, and expanding its presence outside this country. It currently has nine staff with a registry of 750 boats from about 600 charter partners in 30 countries. In January last year, it raised $200,000 from angel investors in this country.

Today, Ms Badri’s CMA has about 2,000 students on its books, including pupils it coaches across eight Dubai schools including Jumeirah English Speaking School and Kings Dubai.

When she initially secured her first bank loan, she needed a male guarantor. That was not the case last year, although it was by no means an easy ride.

“This time there was a lot of paperwork, much of which would be online in the UK or the US,” she says. “But eventually I managed to get the much required loan.”