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BORROWING
MONEY
Why Banks Think the Way They Do
Gene
Dailey, SCORE 513 Counselor
Banks
don’t lend the Bank President’s money or the directors’ or
officers’ money; they lend YOUR money, the depositor’s
money. Therefore they are subject to periodic exams to
determine that the risks that they take are prudent and
do not exceed the standards established by the regulatory
authorities (FDIC, Comptroller of the Currency, Federal
Reserve, and State Banking Departments.)
Lending
to small business is considered, in most cases, very risky.
The principal (s) are usually inexperienced and untried.
Can they manage the cash flow to assure that the bank loans,
the accounts payable and other debt is paid when due? Can
they manage the business in a way that will produce profits?
If there is no profit the debts will not be paid.
Banks
require that the owners of a business contribute capital,
whether it is cash, inventory, or equipment, i.e., some
asset that has true value. This is common sense. It is
the incentive to cause the owner to work harder to conserve
the money he/she put into the business. Without it the
owner could wake up some morning and decide that operating
the business is too difficult. If the business were shut
down the bank would be the big loser, not the owner.
Everybody
talks about Collateral. Yes it is important, very important. However, it is not the
number one consideration. The most important consideration
is Cash Flow.
Can the bank be reasonably sure that there will be sufficient
cash flow to pay the loan? This is the bank’s primary
consideration. Collateral is secondary. Banks do not
like to liquidate collateral to pay off a loan. It is
costly and it is time consuming. Any good bank-lending
officer will attest to this statement. In most cases
the principals will be required to personally guarantee
a business loan and will be required to allow the bank
to place a lien on their real estate. However, banks hate to
foreclose on personal real estate. Not only is it a costly
and lengthy procedure but the banks are concerned about
the adverse public relations that it causes in the community.
It
is extremely difficult to get a bank loan to start a
business simply because there is no history to determine
if the business will be profitable. Therefore the risks
are greater then the bank can afford. Banks like to see
at least 3 years of profitable business history before
they are willing to consider a business loan. A
home equity loan is usually the best way to borrow to acquire
the money to start a business, assuming the borrower has
equity in their real estate. Of course, the borrower then
risks the loss of the home in the event the business fails.
The borrower should apply for the home equity loan while
still employed.
Other
ways to finance a start-up: savings, loans from family
and/or friends, venture capital firms. Be advised that
venture capital firms will only consider high-profit business
and in almost all cases will require that the owner (s)
give up a piece of the business.
SBA
does not give loans directly. They may guarantee business
loans that banks consider marginal. Most banks will ask
the SBA to guarantee loans if they feel that the risks
involved are greater than they are willing to accept. A
business loan borrower may ask the bank to consider a SBA
loan if the bank rejects a conventional business
loan request. In all cases the SBA will require the guarantee
of the principals and spouses and in most cases will require
the principals to pledge their personal assets, including
real estate. SBA will also require that the owners contribute
capital. The interest rate on SBA loans is usually comparable
to conventional business loans.
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