Introduction to Financing and Banking for Entrepreneurs

Overview of the Class

• A welcome to the principles of entrepreneurship class with special guest, Kathleen, who has extensive experience in the banking sector.

• The aim is to educate students about the difficulties and processes involved in securing financing for business ventures.

Background of the Speaker

• Kathleen is an SBA (Small Business Administration) lender with over 23 years of experience in various banks.

• Currently works for Webster Bank, a regional bank located in Connecticut, serving New England and New York.

• Brief explanation of the SBA program:

  • Definition: The SBA provides guarantees to banks to facilitate loans, making it easier for entrepreneurs to secure financing, especially when they lack substantial assets as collateral.

  • Example: On a $5,000,000 loan for a service business with low assets, the SBA may provide a 75% guarantee, thereby reducing the risk for the lender.

Understanding SBA Lending

The Role of Regional vs. National Banks

• Importance of regional banks in the loan process compared to national lenders:

  • Regional and community banks typically focus on building relationships with borrowers rather than treating transactions solely as numbers.

  • National lenders may not engage in small loans or lines of credit as they are often structured for larger transactions since they resell these loans on the secondary market.

  • Definition of small loan: Many national lenders do not engage in loans under $1,000,000, while regional banks may be more willing to consider loans as small as $250,000.

Finding SBA Lenders

• Each state has a district office for the SBA, which ranks lenders based on the volume of SBA loans issued.

• Potential entrepreneurs can find local SBA lenders via the SBA website or by contacting district offices directly.

Building Banking Relationships

Importance of Relationships in Lending

• The personal relationship between the borrower and banker is crucial, especially with community banks that foster ongoing interactions.

• An example from Kathleen’s experience with a family-run bank illustrates that long banking relationships can serve as a substitute for credit scores, reflecting reliability and trustworthiness.

Starting Early with Banking Relationships

• Young entrepreneurs are encouraged to build banking relationships early when preparing to launch a business, even before seeking loans:

  • Proactive engagement with banks can facilitate smoother future lending processes but ensuring that any discussions are meaningful, i.e., when a solid business plan is available.

  • Building knowledge and a business plan ahead of time is essential, even if individual bankers may not remain in place by the time the entrepreneur is ready to apply for a loan.

Financing Startups

Common Funding Sources for Startups

• Most startups are financed by personal means such as:

  • Friends and family

  • Credit cards

  • Home equity loans

• Startups typically do not secure bank financing until they demonstrate some profitability due to a lack of historical financials.

Recommendations for Personal Financing

• If using personal funds, it is crucial to keep business expenses separate from personal transactions to ensure clear financials:

  • Use a business credit card specifically for business-related purchases and keep detailed records of expenditures to simplify future financing applications.

  • Important Advice: Ensure that all personal debts are separated from business finances as the SBA does not allow the refinancing of personal debts for business.

Analyzing Business Viability for Loans

Factors Considered by Lenders

• Lenders consider:

  • Business bottom line: Revenue minus expenses = net income.

  • Cash flow evaluation: Adding back interest and depreciation to determine the cash available for debt service.

  • Expected cash flow should be greater than the loan by a specific ratio (e.g., $1.20 in cash for every $1.00 of debt).

• Personal financial health is also taken into account, particularly debt-to-income ratios which should generally be below 40%.

Understanding Liens

• Explanation of lien position: When a bank provides financing, it often files a lien securing its interest in a business’s assets, recorded through a UCC (Uniform Commercial Code) filing via the state.

• Importance of knowing lien positions:

  • Banks want to maintain first position in any financing arrangement. Therefore, clients should avoid multiple loans across different banks for the same purpose.

The Loan Application Process

Documentation Required

• Lenders, particularly government-backed lenders like the SBA, typically require comprehensive documentation:

  • Three years of historical business tax returns.

  • Three years of personal tax returns.

  • A year-to-date Profit & Loss statement.

  • A balance sheet and a personal financial statement, which often includes assets of a spouse, regardless of their participation in the business.

  • Significance of a Business Plan: Essential for showcasing a stable foundation for starting a business and hence, more likely to receive favorable consideration for loans.

The Relationship with the Loan Officer

• The loan application process requires a strong relationship with the banker, who guides the applicant through documentation and prepares them for potential pitfalls.

• Bankers want to see well-prepared, substantial business plans rather than just forms filled out hastily. A solid business idea potentially saves time and resources in the application process.

Conclusion

Key Takeaways for Entrepreneurs

• Starting and running a business requires careful planning and understanding of both personal and business finances.

• Building a strong relationship with local banks and having a solid plan will enhance the chances of being approved for a loan.

• Entrepreneurs should use available resources—like SCORE and SBDCs—to strengthen their business plans before approaching lenders.

• Personal guarantees are a common necessity in business financing, indicating a personal commitment to repay any borrowing, which is essential for lenders as they assess risk.