Rule #1 of a Business Line of Credit – Banks Finance Performance Not Vision:
As a business owner, you have probably felt the wrath of your bank’s credit policies and are still wondering what happened; or worse, still have a relationship with them on their terms! What you probably did not realize is that it has always been a one sided, unrequited relationship. The majority of business owners have little or no idea how bank credit works and how it can affect their operations. Unfortunately, business owner will constantly return to their banks repeatedly expecting a different outcome (definition of insanity).
Have you ever been declined for a business loan that you needed to increase or improve revenue? The cardinal sin of the majority of business owners is that they use a completely different matrix for finance than their banks. This is because the majority of business owners make two erroneous assumptions:
- A short term liability like a business loan is exactly like cash on a balance sheet
- Internal growth rate is a function of debt service
First, I will address number one. Have you ever heard of a company that “grew into bankruptcy”? Sounds counterintuitive but this is how it happens; Although an operating line looks and smells like cash to a small business owner because they can purchase inventory, make payroll, expand their business, etc; it is a liability! The bank knows this, which is why the finance performance not vision. They cannot accurately measure your financial condition without determining the ability to cash flow the debt you as a business owner are requesting from the bank. Business owners generally dismiss this because they treat liabilities like cash but neglect to acknowledge the drag they are creating on their business.
This leads to number two. Internal growth rate is the retained earnings of a business that also projects the ability to handle debt. This is what banks look for. If your projected growth is beyond the internal growth rate your company can handle, by definition you need external financing. What if you have a potential for explosive growth as the result of an improving economy? Refer to rule number 1! For a lack of a way to put it, banks do not care. They are more concerned about debt service and collateral and vision provides neither.
To be fair to banks, it is extraordinarily difficult to quantify their client’s operational capacities without underwriting performance. Performance is the matrix for banks because performance signals several things:
- Barrier to entry has been met
- Equity is more than likely build into the success of the business
- There it probably more collateral
- The businesses systems and operations are prove
- Core competencies are well defined
Therefore, a bank can peruse through the financial condition of the prospective business and determine their ability to debt service the short-term liability they are providing with depositors cash deposits who are expecting a guaranteed return on the money. The truth is, the cost of money from banks is very inexpensive however, it is many more time more difficult to fit within their credit box, which is why vision is not financed.
There are options but you need to be prepared to divorce your bank and find other financial products. Here are some very solid suggestions:
- Factor your receivables – It costs more but it is boundless. As fast as you can turn your A/R is as fast as you can have cash in hand to cease all the opportunity in your market. Even if you qualify for a business line of credit, that may not be enough to finance your growth and if you commit to this, refer to rule number 1. Always treat this as a method to find a new plateau for your business and once you have capitalized on the increase market share and growth rate is between 2-5% return to the bank.
- Finance your building with a non-bank SBA Lender – Non-bank SBA lenders are transactional lenders. They will generally subordinate soft assets like A/R and Inventory, which will allow the business owner to fully utilize all credit instruments to their maximum potential.