I. Background information on the credit discussion

1. New requirements demand more preparation

For small and medium-sized enterprises (SMEs), obtaining a bank loan is often a decisive step towards achieving their own business goals, further company growth, securing their market position and transforming into a sustainable business model. Accordingly, it is important to discuss financing with the person from a bank's corporate customer advisory service (CCS). In section II from page 10 onwards, you will find a practice-oriented checklist of questions that you can use to prepare for the upcoming meeting with the bank.

In addition to the previously relevant, primarily economic information about your company and the associated business model, ecological, social and governance aspects (environmental, social and governance criteria, ESG criteria) are becoming increasingly important when granting loans. Companies with sustainable practices are often considered less risky by financial institutions. In addition, there are stricter regulatory requirements that are being enforced by governments and supervisory authorities worldwide. Among other things, these require financial institutions to report transparently on ESG key figures and to take sustainability aspects into account in their lending decisions. In addition, there is demand from investors for ethical and sustainable investment opportunities, which means that financial institutions are increasingly offering such products. Companies that prioritize sustainability in their business models can thus gain easier access to funding. In addition, sustainable practices can lead to cost savings and operational efficiency, which is viewed positively by financial institutions. In light of these developments, loan negotiations have become more complex for companies and their systematic preparation is of great importance for a successful loan application. The additional consideration of sustainability aspects also poses particular challenges for many SMEs - both in terms of practical reporting and due to the uncertainty regarding future market developments.

These developments relate to the following aspects:

• Risk management: financial institutions are recognizing and weighting ESG aspects more than before when assessing risk. Companies that tend to have poor sustainability practices may have a higher risk profile, which can affect their ability to repay loans. As a result, more and more lenders are integrating sustainability criteria into their risk assessments to mitigate potential risks and therefore any losses.
• Regulatory requirements: Governments and regulators in many countries are enforcing stricter environmental and social standards for financial institutions. These include transparency requirements for reporting on ESG indicators and the integration of sustainability aspects into lending decisions. In order to comply with these regulations, banks will have to prioritize sustainable financing in the future (e.g. through the green asset ratio).
• Investor demand: Investor demand for ethical and sustainable investment opportunities is increasing. Financial institutions are responding by offering financial products and related services that meet these preferences, including sustainable loans and green bonds. SMEs that are particularly sustainable may have better and easier access to finance as they match investors' priorities.
• Cost reduction and efficiency: The introduction of sustainable practices can lead to cost reductions and operational efficiency for SMEs. Lenders recognize the importance of financing projects that promote energy efficiency, waste reduction and resource conservation. Loans for such initiatives may come with preferential terms or lower interest rates to incentivize sustainable business practices.
• Competitiveness in the market: SMEs that integrate sustainability into their business model can gain a competitive advantage in the market. They appeal to environmentally conscious consumers and gain partnerships with like-minded organizations. Lenders may view these companies more favorably as they consider their long-term viability and resilience in the face of changing market dynamics.

 

2. The lending process in detail

2.1 How does the lending process work?

• Loan application: A meeting is arranged with a corporate client advisor from the bank to clarify the loan requirement, the purpose and possible loan collateral. Business models and sustainability aspects are also discussed.
• Review of the loan application: The corporate client advisor submits the loan application and a corresponding initial vote to the back office. The back office is the department of a bank that is not in direct contact with the customer but is entrusted with the decision to grant a loan. The the corporate client advisor is therefore an important upstream instance in the lending process. Based on this, the back office checks the creditworthiness, debt servicing capacity and required loan collateral.
• Rating: The back office prepares a rating. From this year onwards, the companies' sustainability reports are also taken into account.
• Decision on the loan application: The back office decides on the loan application.
• Determination of conditions: The corporate client advisor decides on the conditions of the loan, taking into account the vote of the back office.

Credit competencies vary between the banks. The back office usually decides on loans based on creditworthiness, ability to service debt and collateral. Higher credit volumes or poorer ratings are decided at higher levels. Business policy requirements and regulations also influence decisions.

2.2 What is important for good cooperation with a bank?

To work successfully with banks, you should consider the following:

• Conscious selection of the bank: make your decision not only based on the conditions, but also on the quality of the business relationship, expertise, commitment and trust. Continuity of contact partners is important for a close and trusting relationship.
• Maintain multiple banking relationships: By having business relationships with several banks, you reduce your dependency, can compare better and have a stronger negotiating position. However, your main bank should be the one with which you conduct the majority of your business and on whose support you can rely in times of crisis.
   

 

2.3 How do I prepare for the meeting with my corporate client advisor?

In order to negotiate loans successfully, you should prepare thoroughly in advance. These points will help you prepare for the meeting:

• Demonstrate entrepreneurial competence: Demonstrate your entrepreneurial skills and expertise. Be well prepared and know your business figures.
• Demonstrate your company's performance: Show the banks that your company is efficient and adequately protected against risks. Back up your statements with current financial data and information on the organization of your company.
• Market and industry knowledge: Explain to the banks the market development and competitive situation in your area as well as the strengths of your company. Convince them of your company's positive future prospects, ideally on the basis of well-founded budget figures.
• Realistic assessment: Avoid making unrealistic promises.
• Take advantage of advice: Take the opportunity to involve consultants and apply for government consultancy grants. Find out about relevant programs from chambers of industry and commerce, which may vary from state to state.

 

3. The composition of the financing

The financing of a project usually consists of several coordinated components. From the perspective of the financing credit institutions, you as an entrepreneur should contribute an appropriate amount of equity. The remaining financing requirements are then covered by other financing components (borrowed capital, mixed forms).

3.1 The individual components of financing

Before you seek financing, it is important to determine your exact capital requirements. This is usually made up of investments, working capital and liquidity reserves.

Various building blocks are available for financing, which are based on your overall capital requirements and your strategic measures. A comprehensive business plan is crucial here. Commercial banks often provide advice on applying for debt capital and can involve other institutions such as the KfW Banking Group, state development banks or guarantee banks. Chambers of industry and commerce can also be asked for expert opinions.

The cooperation of several capital providers, both debt and equity providers, can have a positive effect on the financing decision, as the risk is spread across several partners.

3.2 The importance of equity

It is recommended that the equity share amounts to at least 20 percent of the financing requirement, depending on the loan volume and the financing components selected. It is advisable to keep reserves for possible liquidity bottlenecks and not to use the entire equity when applying for a loan. An external company investment can increase equity and improve the rating, as the relative proportion of borrowed capital on the balance sheet decreases. The involvement of several providers of capital, including equity providers, can therefore be advantageous. However, it is important to note that an equity investment can result in voting rights or shares, which allows the investor to influence the company's development.

3.3 Alternatives can create independence

In order to position themselves as independently as possible in terms of financing, entrepreneurs should take the following measures:

• Diversify lending relationships: Seek credit relationships with at least two banks in order to better compare prices, service and risk assessments.
• Use leasing: Take advantage of leasing offers for movable assets such as machinery and technical equipment. Leasing providers can often value these assets higher and have more experience in realizing such collateral. However, companies usually have to be on the market for a few years before they can conclude leasing contracts.
• Examine factoring to finance receivables: Consider whether factoring, i.e. the transfer of receivables, is an option to improve their liquidity and planning uncertainty.
• Medium-term financing of overdrafts: Finance the balance of overdrafts over the medium term (one to two years) to secure liquidity, reduce interest costs and improve balance sheet ratios.
• Use public funding programs: Consistently check the possibility of using public subsidy programs. Actively discuss this with your bank advisor or contact chambers of commerce, whose advisors can also support you in discussions with banks (you can find more information on this in the Fin.Connect.Praxisinfo Nr. 1).

 

4. The most important question: Am I creditworthy?

The bank will check your creditworthiness and credit standing before making a loan decision. In the case of creditworthiness, it is checked, among other things, whether all interest/repayment payments can be made properly.

4.1 How does the bank assess my creditworthiness?

Transparent criteria are required for fair lending. Banks assess your company using a standardized rating procedure to analyze business opportunities and risks. The rating result, i.e. the creditworthiness, determines the possible credit limits and conditions of your loan. The rating procedure varies depending on the sector and company size to ensure tailor-made guidelines. Banks use different procedures, which can lead to different results, but also allows you to make comparisons and determine your own house bank strategy. As a corporate customer, you also submit business figures such as annual financial statements or income statements with your loan application. The automated evaluation of these quantitative factors forms the first part of the rating process. The following quantitative factors are included in the rating score (not exhaustive):

Table 1: Quantitative factors of the rating

Key figure	Reference value	Significance
Equity ratio	Equity	Liability basis as an indicator of a company's risk-bearing capacity and creditworthiness
	Total capital (balance sheet total)
Debt-equity ratio (static)	Debt capital	Indicator of the degree of dependence on creditors
	Equity capital
Debt-equity ratio (dynamic)	Debt capital - liquid funds	Debt repayment capacity in years (approx. 3 years)
	EBITDA
Cash flow	Balance of cash inflows and outflows generated in a period	Measure of internal financing power as an indicator of independence from external providers of capital
1st degree liquidity	Cash and cash equivalents (cash on hand, bank balances, securities available for immediate sale)	Degree of solvency as an indicator of how quickly current liabilities can be repaid using available cash and cash equivalents
EBITDA margin (profitability)	EBITDA	Profitability figure as an indicator of the company's earning power
	Turnover
Turnover development	+-5 –10 %	Indicator of the stability and future viability of the business model

Source: own presentation; IHK for Munich and Upper Bavaria.

The second part focuses on qualitative characteristics. Qualitative characteristics are assessed using questionnaires or customer interviews. The following factors play a role here:

• Quality of the management
• Quality of the accounting system
• Quality of the company location
• Corporate strategy and planning
• Succession planning
• Industry, market and competitive situation of the company
• Dependencies on customers, suppliers and personnel
• Employee structure (age, qualifications)
• Other factors such as account management, difficulties in repaying loans, previous business relationships and ratings from credit agencies.

 

4.2 What role do sustainability aspects play in the valuation?

The importance of sustainability in the financial sector is increasing inexorably. The latest revisions to the “Minimum Requirements for Risk Management” (MaRisk) by the German Federal Financial Supervisory Authority (BaFin) clearly underline this development. In future, ESG criteria will also play a central role in the lending process. Credit institutions are now obliged to request comprehensive sustainability information from their borrowers in addition to traditional financial data. This includes, for example, environmental balance sheets and information on the social responsibility of a borrowing company, which are included in the assessment of creditworthiness. In many cases, there are still no uniform standards on how banks obtain the required sustainability information from the respective company. Many banks are currently developing their own questionnaires and query processes, which are requested and checked in the course of financing discussions with corporate customers. 
 

Companies with a sustainable business model can expect better credit terms, while companies with little or no sustainability activities can expect higher financing costs and shorter terms. In short: companies that neglect sustainable practices can expect less attractive credit conditions. It is becoming clear that the future viability of a company is no longer assessed solely on the basis of financial indicators, but also on the basis of its ESG performance. A proactive stance on sustainability will therefore not only bring financial benefits, but also secure long-term creditworthiness.

Even if sustainability reporting on the basis of the Corporate Sustainability Reporting Directive (CSRD) initially applies to a limited group of companies, small and medium-sized enterprises will also increasingly have to report on their sustainability activities in order to obtain attractive credit terms. For financial years starting from January 1, 2024, the reporting obligation under the CSRD will initially apply to a limited group of companies, which will then be successively expanded. 

• For financial years beginning on or after January 1, 2024: public interest entities with more than 500 employees
• for financial years beginning on or after January 1, 2025: all other large companies under accounting law
• For financial years beginning on or after January 1, 2026: capital market-oriented SMEs, unless they make use of the option to defer until 2028.

 

4.3 Who assesses my creditworthiness?

Standardized automated rating procedures for determining creditworthiness have a significant influence on decision-making and limit the decision-maker's subjective leeway. These procedures classify the creditworthiness of the borrower and their loans according to their default risk in various risk classes (very low, low, manageable, still acceptable, high or no longer acceptable). The risk classes indicate how likely it is that a loan will default within the next twelve months. Banks do not use standardized rating procedures. Comparisons are therefore difficult and only possible by taking into account the probability of default applicable to a rating.

4.4 How do I identify any weaknesses in advance with a self-diagnosis?

A self-check is advisable before a credit discussion. Here is a checklist for a possible procedure:

• Apply for a self-disclosure and check stored data on the company and on the entrepreneur's personality with Schufa, credit agencies and the debtor register.
• Check that important contracts and documents are up to date and have not changed.
• Analyze annual financial statements, possibly with the help of a tax or business consultant.
• Create an annual plan for three to five years and an annual plan with a target/actual deviation analysis.
• Gather information on sustainability criteria in the company and the supply chains.
• Carry out a customer analysis (ABC analysis) to find out which proportion of customers generate around 80 percent of revenue.
• Compare yourself with the competition and identify your own strengths and weaknesses in order to take appropriate preventive measures.
• Ask your bank advisor for an assessment of your creditworthiness, collateral and risk classification.
• Check that your documents are complete.
• Observe and analyze the market in order to objectively assess your own position.

 

4.5 What to do in the event of a loan refusal?

If you receive a loan rejection, it is important to find out the reasons first. Review your financing request and try to dispel the bank's doubts. Consider whether your overall plan can be achieved in smaller stages to reduce financing risks. Your sector may be one of those with poorer future prospects. Check whether your company is actually dependent on industry trends and present the bank with appropriate solutions. Particularly in sectors classified as unsustainable, you should present good arguments for continued financial viability.

Negotiate with other banks. Banks take care not to hold too many loans in one risk class (e.g. sector or region). Not every rejection is therefore a problem for you. However, if your loan request is also rejected by other banks, there are obviously major creditworthiness deficiencies that you should rectify as quickly as possible. Think about alternatives. Especially for small amounts, it is sometimes not worthwhile for banks to grant loans. In such cases, online loan brokers can be an alternative. Relatives or employees may also be interested in giving you a loan or taking a stake in your company. Consult with your advisor. Discuss the points and issues together and consider how you can proceed.

II Guide to preparing for the credit discussion

1. Overview of the most important tips

With these basic tips, you can prepare for the meeting with your advisor in a targeted and step-by-step manner and impress them with your specialist knowledge of the company. 

• Take the initiative yourself and arrange an appointment in good time: You should take the initiative for a loan discussion. It is advisable to have a discussion early and without any time pressure. Provide the bank with the documents at least one week before a planned meeting. Keep your contact at the bank regularly, promptly and without being asked to update you as part of an existing business relationship.
• Choose the right negotiating partners: Negotiate with a contact at your bank who has specialist expertise and knowledge of your industry and business model. Also look for banks that have experience with public development loans.
• Thorough preparation and documents to support the arguments: Prepare carefully for the discussion. Determine your negotiation goals and strategies. Prepare meaningful documents in good time and think about convincing arguments and answers to possible questions. Obtain the necessary information early and provide the bank with the documents before the discussion. Have your current credit lines, loan collateral and conditions (interest, fees, etc.) ready. Answer the question for yourself: what does the bank want to know and why? This way you can prepare your documents accordingly.
• Create an appropriate framework for the discussion: Arrange an appointment in advance for which you can prepare with sufficient time. The framework of the appointment should also offer enough time for an intensive exchange. Focus on the essentials.
• Appear confident, but remain realistic: Remember that your negotiating room depends largely on the bank's risk assessment. Remain realistic and strive to build trust!
• Negotiate: At their core, loan discussions are negotiations. It is therefore often a good idea to negotiate the best terms for you with your bank. Review the entire package of terms (your total commitment) and point out further cross-selling potential.
• Involve advisors: For important bank negotiations, it is advisable to also involve your spouse, a senior employee or your advisor. Be sure to agree on the content of the discussion and the tactics in advance.
• Invite them to a tour of your company: Invite your bank advisor and decision-makers at the bank to a meeting and tour of your company. Make all the necessary arrangements for a pleasant and uninterrupted discussion, including a suitable room, drinks and no interruptions from phone calls or employees. Have all the necessary documents to hand and convey the performance of your company.
• Obtain comparative offers: Always request alternative offers from other banks and lenders (e.g. leasing or factoring companies). Insist on written offers with all terms, required collateral and other conditions. Also take advantage of the financing consultation days of your local Chamber of Commerce and Industry.