Sunday, March 18, 2001

Financing startups


Bank on it: Loans hard to come by

By Rhonda Abrams
Gannett News Service

        When asked why he robbed banks, notorious robber Willie Sutton replied, “Because that's where the money is.”

        When looking for financing for their business, many novice entrepreneurs also think of going to a bank, likewise assuming that's where the money is. But they might find they're just about as welcome as Willie.

        Banks can indeed be an important, if not critical, part of financing a business — especially the growth of an existing business. In fact, as your company develops, you'll want to find a good bank and develop a strong working partnership. But you'll find banks are not an appropriate place for startup capital.
       

"Risk/reward ratio'

        Banks' lack of responsiveness to new business loans can be frustrating. It's important to understand the role of banks in comparison to other kinds of financing sources.

        A key concept is appreciating the “risk/reward ratio.” In other words, there's a direct relationship between the amount of risk you ask someone to take and the reward they receive. The greater the risk, the greater the rewards.

        Let's take two types of financing sources: an angel investor or a bank.

        An angel investor looks at your business plan, experience and team, and decides whether you have a good chance of success. In return for giving you money, he gets a piece of the ownership in your company. If you fail, you don't pay him back. But if you become a smashing success, he gets a portion of every dollar you make. High risk. High potential reward.

        Now, look what happens if you go to a bank. In return for lending you money, it charges you interest. It gets the same amount of money whether your business barely makes it or becomes a Fortune 500 company. Limited reward. So it has to limit its risk. Instead of your business prospects, the bank is concerned about your ability to repay the loan.
       

Under a microscope

        Typically, banks look for what is referred to as the “Three C's of Credit.” If you approach a bank for a loan, expect to have the following examined:

        • Character or Credit: The most important thing a bank will look at is how you've handled credit before. There's a Catch 22 in that: If you've never borrowed money, you may have a hard time borrowing money. In the early years of a business, most banks will look at the owner's personal credit history rather than the business itself.

        Most of us have established some credit history — through credit cards, mortgages, car payments. Banks will examine your credit report to see whether you paid your bills on time and repaid loans in full. A way for a business to establish its own credit history is by setting up accounts with suppliers (printers, office supply stores, shipping services) or landlords, so the business itself will have good credit “character.”

        • Capacity: There's an old belief that banks lend money only to people who don't need it. To some extent, that's true. Banks lend money only to those with the likely ability — or capacity — to pay back the loan. In other words, do you make enough money to be able to handle all your debts and responsibilities?

        Unfortunately for most business owners, the main criterion banks typically use is the ratio of your salary or draw to your debts. This means that some people with other substantial assets and a good credit history may still look as if they don't have the capacity to handle another loan.

        • Collateral: To reduce risk, especially on very large loans (such as home mortgages), banks may require you to pledge other valuable assets as security for the debt. Often, as in the case of equipment or property loans, it is the physical asset itself. But it could be anything of value. Keep in mind, though, that banks are in the business of lending money, not repossessing machinery or stores, so they're still going to be looking at your ability to repay the loan itself.

        As frustrating as it seems, realistically, banks lend money to companies that have been in business for at least one or two years. But don't be discouraged: One day, you may find your bank to be an important, even eager, partner.

        Rhonda Abrams is the author of The Successful Business Plan and Wear Clean Underwear: Business Wisdom from Mom. For free tips from Rhonda, register at www.RhondaOnline.com or write her at 555 Bryant St., No. 180, Palo Alto, CA 94301.

       



Economy batters local companies
Shutdown at Comair would have big impact
Comair vs. pilots: at a glance
Some sectors rise against the tide
BYCZKOWSKI: Warm welcomes remain for startups
- Financing startups
CoActive promises cooperation to clients
Longaberger bio a best-seller before release
Tristate business notes
What's the Buzz?