Banks and Entrepreneurs
A glimpse into the mind of a banker can be very instructive for entrepreneurs, especially those who mistakenly think that bank financing is out of their reach. Bankers, who are among several types of business professionals that start-up businesses should keep in their stable of advisors, like to recite the five Cs of lending. Brad Schroeder, president and CEO of DMB Community Bank, sums them up from a lender's perspective:
In the bank
If a start-up business can pass that gauntlet of tests, bank financing is accessible despite pressure from federal regulators to improve the quality of bank loans. As Schroeder explained, it's important to understand how banks make the bulk of their money – by playing matchmaker.
"I need to have a fixed level of income that requires principal payments of $800,000 a month, so I need to write $800,000 in new loans every month just to keep the balances the way they were, to keep my income the same," Schroeder explained. "If you look at the current environment, the reality is that all businesses, including banks, have costs that continue to go up. I have to get new business to withstand those operational cost increases."
One report suggested that community banks are handicapped by the need to repay Toxic Asset Relief Program money, and some banks that accepted TARP money might hesitate to lend, but Schroeder indicated the same profit motive applies. "The only way they are going to repay TARP is to make money," he stated, "and the only way to make money is to lend."
Banks could raise their fees, but they face competitive pressure to keep them reasonable, especially in tough times, he added. "We've all gone through a couple of tough years, and we've taken back more money than we ever wanted to, but it's starting to turn, which is really encouraging," Schroeder said. "Everybody got very conservative for awhile because everybody got scared. I feel things are loosening up a little bit."
Gridlock may be loosening in terms of cash availability, but banks are sticking to some of the more formidable lending terms that marked the Great Recession. Entrepreneurs must prove themselves trustworthy because banks have to be able to evaluate their character, which either comes from a prior banking relationship or a referral from a trusted client.
Show me the money
What do entrepreneurs have to show in order to get bank financing? Thomas Spitz, CEO, and David Fink, president, of Settlers Bank, can speak of the entrepreneurial experience firsthand, having started the bank in 2007.
They, too, had to raise capital and secure loans, but the key thing they look for when considering loans is whether an entrepreneur's business concept is well thought out. Have they put it to paper, run the numbers (revenue and expenses) and, most importantly, do they have experience in the field in which they want to start their own business? That's not always the case.
"It's important to stick with what you know," Fink said. "If they are starting up a whole different type of business, it's going to take a lot of extra effort to convince anybody that they really understand not only the business, but the industry they are getting into."
Having contracts in hand would be helpful in establishing cash flow, but there is no substitute for explaining the narrative of the business model, and how it will be executed, in straightforward terminology. Said Spitz, "I need to hear certain things from entrepreneurs: 'This is what I intend to do. This is what I intend to sell. This is how I'll make money, and this is how you will get your money back.' You've got to make it simple.
"So someone who can come along with the contracts, that makes it real enough to say, 'I not only believe I'm going to sell these units, but I've got a contract to actually sell them.' All those things enhance the story, but what is critical is a common-sense, basic story told in terms that anyone can understand."
These days, bank customers also must have some skin in the game, and that's in addition to collateral that might be needed for repayment. Having some of their own money in the deal lends support to the usual due diligence involving background checks, recent tax records, and personal financial statements. All of those things demonstrate financial wherewithal, the ability to explain your business, and how you intend to execute your plan because few banks will lend to entrepreneurs who lack a well-crafted business plan.
"The more I understand and can figure out why this is such a good idea, the easier it is for us to make a [lending] decision," Schroeder said.
An understanding of cash flow fundamentals, particularly expenses, also will go a long way toward securing a loan. "In situations where we take a bigger chance, we have to know they understand where their expenses are," Schroeder explained. "We give them tools to help with budgeting if they don't understand the ins and outs of the expenses they are going to have.
"Before we get too involved, we're looking at budgeting on a monthly basis, rather than quarterly, to see how good they are at calculating their expenses."
If a bank has other clients in the same industry the entrepreneur is wading into, it might already have a pretty good idea of the cost drivers. Those drivers may differ by location, but bankers may already know more about that expense picture than a start-up owner does, so be prepared.
"A big piece of the puzzle is whether they really understand their costs," agreed Fink. "They need to be able to understand their costs and hopefully they have gone out and priced whatever it is they will be selling or manufacturing, so they can cover overhead and create a profit."
Provided their concept makes sense to a banker, start ups also might be able to take advantage of a reduced appetite for borrowing. The reduction in loan requests, combined with the bank's need to make loans, means entrepreneurs should not be shy about asking about traditional bank financing and transactional account support – no matter what they've heard about the current lending environment.
Even if the answer is no, the process of working through these issues with a banker could be illuminating and beneficial in the long run. "If it's a 'no,' we like to coach and encourage and try to figure out a way to get that answer to a 'yes' at some point," Fink said. "It's better to get that quick 'no' so that you can move on and take the steps necessary to get to a 'yes.'"
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