Bank-based Financing

When one wants to borrow large sums of money, a bank is an obvious place to begin. The aspiring entrepreneur must be aware though that the banks are not charity organizations. They give loans in order to make money for themselves. They do not make money by funding extraordinarily risky or unproven business ideas. It is for this reason that acquiring a business loan can be difficult. Lending institutions by nature are risk averse, and a startup business is possibly the most risky activity one can pursue.

It is important to note that we are talking about business borrowing. Most people are familiar with personal borrowing, and if you approach the bank using the wrong vocabulary, you will likely end up on the personal borrowing side of things. The difference between personal borrowing and business borrowing is that in personal borrowing the bank secures your loan dollar for dollar with equity. In other words, they have siphoned money out of a personal asset, most commonly a home, and are lending it back to you at a low rate. Business borrowing is different. The bank in many ways is your business partner. Situations may vary, but generally a business loan requires the applicant to pay only 20% up front. That means instead of securing a loan dollar for dollar, they leverage their money. In order to get a business loan however requires more from the applicant than a personal loan.

A bank looking at a business loan application will look for several things (which may change depending on your personal area). Generally, a loan officer will first examine the applicant's credit score. A credit score is a very popular measure of the financial responsibility of an applicant. It makes sense for banks because it is a quick litmus test to see what an applicant did with their money up to this point in their life. Most credit score services factor in 25 or more different criteria to come up with a credit score. What those criteria actually are is a bit of a mystery and are a closely guarded secret. It would be prudent for an aspiring entrepreneur to look at what their credit score is before applying for a bank loan. A bank will consider credit scores in the mid-600 range, but generally prefer a score above 700. If the applicant does not fall into this range, we recommend taking steps towards repairing the credit score before moving further.

The next thing the lending institution will focus on is whether the applicant has equity in either a home or significant equipment to secure the loan. Unlike personal borrowing, a business loan does not always require dollar for dollar matching. There are cases when the bank will only require 15% of the total loan amount secured with equity. Note, that this is in addition to the 20% required in cash up front.

If the applicant's bank score, liquidity, and equity are all satisfactory, the bank will take a look at the business plan. It may seem surprising that up to this point, the bank doesn't even consider the merits of the business. The bank's primary focus up to this point has been the merits of the individual because banks realize that the individual in the end is the one that will pay back the loan. A great business concept cannot make up for a bad applicant.

Lastly, the bank will look at the industry profile. Business plans have a tendency to inflate projected earnings and lending institutions are not ignorant to this fact. Once the loan officer reviews the plan, he will likely check the company's financial projections against the data compiled in Robert Morris and Associates (RMA) Annual Statement Studies. RMA Annual Statement Studies covers most major business types and analyzes key financial indicators. If the business sector shows significant risk (negative returns, long delays in accounts payable, etc.) the bank will be less likely to issue a loan. RMA Annual Statement Studies is available in print at most Main Public Library Business reserve desks, and is available online for a fee.