Venture Financing:

Debt vs. Equity

Dealing With Banks

How To Obtain a Commercial Loan for Your Venture

 

By Venture Planning Associates. Used by permission

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Types of Financing

There are many different forms of loans available.  Use your advisors to determine what form might be appropriate for your business.

  • Short Term. An example of short term financing would be a retailer involved in a seasonal business. He may borrow money for 90‑120 days, pay interest during that time, and then pay off the loan in full.

  • Line of Credit. The entrepreneur can borrow against it when needed, but repayment would be for a longer period of time.

  • Factoring of Receivables. Here the bank controls the collection of the company's accounts receivable, either through direct deposit or through monthly loans as receivables are presented.

  • Receiving Credit. This is not seasonal, but for businesses that are in up and down cycles, for example contractors. This type of loan should not be used for the purchase of assets.

  • Long Term Loans. This would be used to buy assets (trucks, equipment, etc.). The repayment period is usually 3‑5 years. But typically, startup operations have paybacks of 5‑7 years.

  • Combination of Long and Short Term. This is called "the revolver that turns out".  Typical uses for this type of financing would be a high growth phase company to help finance receivables or build up inventory. Loan is set up for repayment in 3 years, until the business levels out.

If you don't understand the terminology or jargon of the banking industry, ask the banker to explain. Find out exactly what you are getting into. The borrower should ask lots of questions.

Build Personal Relationships

Relationship banking means finding an individual within the bank that wants to grow with your business and can offer advice and consultation. The entrepreneur should contact the business or loan offices of the bank, then find the individual with a good depth of experience who is willing to work with the business on a daily basis. This person should also be someone who is knowledgeable concerning all aspects effecting businesses. We also make the following suggestions:

  • After preparing your documents (business plan), do not send them in the mail to your banker.  Make a personal appointment with the bank instead.

  • Sit down with the banker and walk through your business plan. Bankers evaluate not only the documentation, but also the person(s) behind it. Give the banker an opportunity to get to know you. The better the banker understands your business, the better equipped he/she is to respond favorably to your loan request.

Debt versus Equity

What Does the Bank Look for in Making a Decision

4Cs of Commercial Lending

Documentation Required to Process a Commercial Loan

Have a Professional Business Plan

Cash Flow Forecast

After the Loan: Maintain Good Communication with the Bank

 

Banking Basics

Banks are businesses too.  They have stockholders to whom they must report and they are highly regulated by federal and state agencies.

  1. Remember that banks only make a profit for their stockholders by making sound loans where they can collect up front fees (points) and also collect interest on the loan as well as recoup the loan principal.

  2. In order to have money to loan, they must maintain adequate reserves (regulated) and may not be able to lend more money until more deposits are made.  (This is one reason they ask that all your accounts be lodged with them.)

  3. The SBA does not lend money.  It only provides a guarantee to banks on risky loans.  In the event that you default on an SBA guaranteed loan, the bank may have the SBA (federal government) make good on all or some of the principal.

  4. Banks may be prohibited or will not lend to certain industries based on their corporate policy, so be sure to ask the following questions before formally approaching a bank:

  • Do you lend on these kinds of projects?

  • Are you lending now? (Can the bank actually make more loans now?)

  • Under what conditions are you making these loans? (Interest coverage ratios, etc.)

  • What information do you need to consider my request?  (Get their checklist)

  • What is the time frame usually associated to complete a loan of this type?

  1. After you have this information, go and develop your business plan and associated documentation.

Establishing Good Credit

If you have not already done so, obtain copies of your personal credit history from the various reporting agencies in your area and be sure to include the national services such as TRW and Equifax.  Also obtain a copy of a Dun and Bradstreet Report on your business.  These will give you valuable insights into your potential for obtaining financing.

If there are errors, omissions or incorrect entries, each agency will provide you with a means of correcting these items. Many times, a divorce, natural disaster, or major economic recession where your customers left you large un-collectible fees have caused you problems.  You are allowed to have each agency place your letter of explanation in the file so that it becomes public record.  Note: do not fudge here; filing a false financial statement can have serious criminal consequences.

Credit cards, while a valid need in today's society affects your credit rating, even if they have a zero balance.  The bank must consider that a potential liability even though it is unused.  So $100,000 in available credit at the 19.8% level on your cards can prevent you from obtaining a much lower interest rate loan at the bank.  Establish a credit line with your bank and then eliminate the cards.

To establish or re-establish your credit rating, first find a commercial lending officer you can work with comfortably.  Next arrange a small business or personal loan and pay it off early.  Continue this process with two other banks in your area.

If you can get all three loans at once, simply use the money from one to pay off the others.  You can use this technique to obtain progressively larger loans.  At one point in the future, you may be able to get a signature loan for $100,000.