Loan risks every small business owner should know

As financial pressures continue to impact small businesses across New Zealand, many are turning to loans as a lifeline. While borrowing can help manage expenses and cashflow it’s important for small business owners to understand the risks involved.

Our latest annual statistics at Financial Services Complaints Ltd (FSCL), a free financial ombudsman service, show an uptick in business lending complaints from small business owners who are struggling to repay their loans. 

A common issue in some of the complaints we are seeing is that the lending was allegedly unaffordable from the start. Often a secondary issue is the borrower feels the lender has been unfair in responding to their request for hardship relief.

So, what should small business owners keep in mind before seeking a loan?

CCCFA protections don’t apply to business loans

As well as seeking independent legal advice, it’s important for small business owners to know that the protections afforded by the Credit Contract and Consumer Finance Act (CCCFA) don’t apply to business loans. The responsible lending obligations in the CCCFA only apply to consumer loans. 

These obligations include the lender having to make reasonable enquiries to be satisfied the loan is suitable for the borrower and that they will be able to repay the loan without suffering substantial hardship.

A business loan often carries greater risk than, say, a personal loan because a lender may:

• Have the power to place a caveat on a personally owned property 
• Require security over assets including the family home or,
• Take personal guarantees.

Many small business owners have put their life savings and family home on the line to build up their business, so the stakes are so much higher. 

We’ve seen cases where people have unfortunately lost homes sold to pay off an outstanding business loan. Sometimes their partner who jointly owned the property was not aware that the lender could sell their home to recover business debt. In one case parents in their 80s lost their family home, after their daughter’s home was sold to pay off an outstanding business loan and the proceeds from the sale were not enough to repay the daughter’s loan in full.

The importance of responsible lending

Although not required by law, we consider, as best practice, that the lender still needs to assess at the time of approving the loan, whether the business will be able to repay the loan. There must be enough evidence to show that the business likely had means to repay the loan. We have seen a few cases where it should have been apparent to the lender, from the start, that the business could not afford to repay the loan, yet it was approved anyway.

In a recent case we investigated, we thought the lender should have obtained more detailed information before approving the loan after the borrower fell into serious arrears within weeks of making payments. FSCL helped to negotiate a settlement between the parties where the debt was reduced and, once the loan was paid, the lender would remove the caveats which had been put in place on two of his properties, including his family home. 

Lenders and borrowers alike benefit when loan repayments are affordable and manageable. In all cases, we will look to ask the lender to do the ‘’right thing” if the circumstances around the loan approval appear unfair and where, if responsible lending rules had applied, credit would never have been granted to the small business. 

Hardship assistance

While borrowers can apply for hardship assistance when struggling to keep up with a consumer loan – and the lender is legally obligated to consider a hardship application – this is not the same for business loans. 

Although offering hardship relief is not required, we encourage lenders to look at granting some hardship relief as it may allow the business to turn their situation around and get back to making regular payments. 

One recent case we investigated was a good example of a lender and a borrower working together to make a hardship payment arrangement that balanced both the lender’s and the borrower’s needs. 

The owner and director of a trade business faced financial hardship two years after taking out a $150,000 business loan. The business owner had provided a personal guarantee for the loan and agreed to a ‘catch-all’ security clause, raising concerns that the lender might sell her home if she couldn’t repay the business loan. She applied for hardship assistance, but the lender declined her application due to insufficient information. With the help of FSCL, the lender and the business owner were able to agree on a new repayment arrangement to address the business owner’s financial difficulties.

Protecting against fraud and scams

Small business owners also need to be aware of common risks when it comes to frauds and scams in order to protect their money. 

With online transactions part of everyday life for most kiwi business owners, scams are becoming more technologically sophisticated with fraudsters constantly designing new ways of scamming their victims. If something seems too good to be true, it probably is.

Recovery of fraudulent transactions on credit cards, or from online money transfer services is often difficult with very limited chances of success. People shouldn’t rely on being able to get a refund in place of carefully considering the trustworthiness of those they deal with online. 

Seeking help

If your business is facing financial difficulties, seek help early. Talk to your lender, consult a financial mentor, or reach out to a business adviser. Early action can prevent problems from escalating, reduce the risk of losing assets, and provide more options for managing debt.

At FSCL, we’re here to help small business resolve disputes with financial service providers. FSCL can take complaints from small businesses (a business with less than 19 employees) about any type of financial service, including credit, finance and loans, insurance, investments, and financial advice. 

Many cases that come to us are helped quickly by our Early Assistance team providing useful information and guidance. If we investigate a case, it will be assigned to one of our case managers. We can award compensation for direct financial loss up to $500,000 +GST and for non-financial loss, such as stress and inconvenience, up to $10,000 +GST.

As long as economic conditions remain challenging, we expect to receive more complaints from small businesses. However, it’s encouraging to see more financial service providers focusing on a fair outcome for their clients and customers. 

This article was originally published in the September 2024 issue of NZBusiness magazine. To read the issue, click here.