XBanker

What’s Your Hurdle Rate?

July 9th, 2008

My mother always taught me that “beggars can’t be choosers” and my father preferred the “don’t be penny-wise, but pound foolish” – either expression is fitting for this topic. In the last week, I’ve had three experiences that made me think about being wise when you need money for your business and understanding the concept of a hurdle rate.

My first experience was a discussion with a consultant to a portfolio of companies in various stages of their business – all with immediate capital needs. We were exploring potential solutions for these people. Most simply needed $50-100k to purchase inventory or to invest in new opportunities – getting the money is critical to their success. Yet, as I started asking questions, I was being shot down with every possible financing option. It was apparent that these business owners were looking for $100k for 2-3 years at less than 5% interest with no colateral and no personal guarantee and they wanted it now, despite their less than stellar credit.

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Fast Cash For Your Business!

June 10th, 2008

Do you need fast cash for your business? Want a small business loan with no personal guarantee? Are you looking for immediate business financing? Chances are that you answered “yes” to all three of those questions. We all want cash for our business and we want it as soon as possible. Unfortunately, the financing world doesn’t always tell us what we want to hear. If you are properly prepared and have a proven track record (as demonstrated by your revenues and your credit) you can probably get more money – and faster than you think. If you are not prepared … well, you reap what you sow.

Most people don’t start looking for capital for their business until it is too late. “Too late” can mean a lot of things: damaged credit, out-of-line ratios, too short of a time frame, etc. These oversights, plus the procrastinator’s itch for a quick fix, are two of the most common ailments we deal with. I wish every entrepreneur understood this truth: accessing capital is a process.

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Not All Industries Are Created Equal

May 27th, 2008

When you are applying for a small business loan or unsecured line of credit at a bank, why do they ask you about your business’ industry? Does it really matter what type of business you run? If you have a history of business success, have stellar business and personal credit, an impeccable resume, and even an outstanding team behind you, the industry you are in shouldn’t play a role in the approval decision, right?

For better or for worse, the truth is that the industry you are in will play a fundamental role in the bank’s decision on whether to lend you money.

Each bank makes their own decision on which industries they “prefer” to lend to, which ones are a little “higher risk” and those that are “restricted”. Even though every bank writes their own rules, there are some generally accepted industry guidelines you should be aware of. The intent of this post is to explore these guidelines, and why banks make these distinctions.

The most basic principle of lending is that more approvals are a direct correlation to lower perceived risk. The more you have invested in your business, the less likely you will be to give up on that dream. Banks like to see you heavily invested! If there’s a discernable chance you will give up on your business in 2 months, your chances of getting some bank to lend you money is slim to none. If the bank determines that it is likely you will give your life for your business and do whatever it takes to make it succeed, then your chances of getting money increase. But what does this have to do with industry?

All banks have identified industries that they “prefer” to lend money to. These preferred industries are perceived to be lower risk. Most of these industries are professionals like Doctors, Dentists, Accountants, Attorneys, etc; people who have earned licenses and/or have gone to school for an insane number of years in order to pursue their business. If I had just graduated from college after 8 years of studying to be a dentist, what are my chances of quitting 2 months after I open my practice? Of course it’s possible, but it’s highly unlikely. Banks employ the same mindset. Generally, professionals have so much of themselves invested in their company, (time, money, etc), that they won’t give up when they hit their first obstacle. The nature of entrepreneurship is that we will inevitably have hard times; the chances of us and others in our industry sticking it out will ultimately determine what risk category the banks place us in.

Some “high risk” industries include Consultants, Investors, Real Estate Professionals, Financial related companies, etc. What does it take to be an investor or a consultant? The answer to that is absolutely nothing. It really doesn’t require one day of schooling or one penny (in most cases) to carry around a business card that says “Consultant”. Lenders understand this and that’s why these types of industries fall into the “high-risk” bucket. This doesn’t mean that banks won’t lend money to this group, because they dish out money every day to these industries – it simply means that the underwriting guidelines will be raised a bit from the “preferred” level. Instead of requiring 2 years in business for a preferred industry, the same bank might require 3 years. Or maybe the credit requirements will be 20-50 points higher. If you find yourself in the “high-risk” category, all hope is not lost; you just need to be a little more prepared before you ask the bank for money.

Each industry category could have hundreds of different types of businesses. I’ve given you only a few examples here to illustrate that not all industries are equal in the eyes of lenders.

Tip of the Day: You need to understand which industry bucket you fall into BEFORE you ask the bank for money. The steps you will take to get prepared for your loan or unsecured line of credit will be different depending on how risky your industry is. Remember, if you are declined for financing, you are basically shutting the doors to that particular lender for about 6 months. It’s better to take a few weeks or even a few months to make sure you are ready before the door closes.

So, how risky does your industry make you look?

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The Differences Between a Business Loan and a Business Line of Credit

May 5th, 2008

Sometimes borrowers use the words LOAN and LINE OF CREDIT interchangeably, but these are in fact two different lending products. I’d like to call attention to some important differences between these two products in this post.

When a $50,000 LOAN is issued to a borrower, the lender expects the entire amount, plus interest, to be paid back in X number of years. When an applicant walks away from the bank after being approved for a LOAN, they usually have a check for the whole $50,000. Each month that a
payment is made, the loan balance decreases. Once the balance hits zero,nothing more is owed to the bank and consequently the bank has no additional obligation to reissue another loan to the borrower. The LOAN has been retired.

When a $50,000 LINE OF CREDIT (LOC) is issued to a borrower, the lender doesn’t expect the entire amount to be paid back at a certain time in the future. (This is usually the case – there are exceptions). When a successful LOC applicant walks away from the bank, they typically don’t
have a check in hand for the full amount; they usually have a checkbook or a credit card with a zero balance. The borrower doesn’t have to make payments on the LOC until they actually spend the money. If they spend the full $50,000 (or some lesser amount) to purchase some advertising for
their business, they are then obligated to start making payments to the lender, according to the LOC Terms.

The most important distinction between a LOAN and a LOC is if the borrower pays the balance down to zero on a LOC then they can spend the money again. If the borrower pays off a LOC a second time, they can continue to “dip in” as needed. It’s a cycle that could last for years as long as a good relationship with the lender is maintained. This is not the case with a LOAN.

There is a time and place where both LOANS and LINES OF CREDIT should be used in your business. If you need money for certain project or for a set period of time, you might want to consider a LOAN. Interest rates are typically more favorable with a LOAN. If you want some emergency money “just in case,” I’d definitely recommend a LOC. This way you don’t have to make monthly payments unless you use it; you don’t want to pay interest on money that isn’t being used. The key is having access to capital, not necessarily having it in the bank.

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What Is The Difference Between A Term Loan And An Unsecured Line Of Credit?

February 26th, 2008

You will find that some banks offer two options to small business borrowers: term loans or unsecured lines of credit – it’s important to understand the difference between a term loans and unsecured lines of credit. The easiest way to think about an unsecured line of credit is to consider it as “access to capital.” If you get approved for a $50,000 line money doesn’t change hands, you simply have access to this money – you don’t pay any interest until you actually use it. With a term loan, you receive the money upfront and begin paying principle and interest for the term of the note.

My bias is towards unsecured lines of credit, because you can build a healthy reserve without increasing your monthly debt burden – until you actually use them. However, a term loan may make the most sense if you know that your cash flow will cover the payment and that you will immediately use every penny from the loan.

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