Loan Stars

The Color of Money

While small businesses and banks would seem to make a great combination, in reality nothing could be farther from the truth. The crux of the problem: Banks are working with other people's money. When customers make a deposit, they expect their money to be present and accounted for when they want to withdraw it. This puts the bank in what many lenders refer to as an "abundance of caution" mode. Simply put, this means banks won't get involved in situations where a loan is at risk, period.

This alone should speak volumes about the behavior of your typical loan officer. Still, many entrepreneurs get angry when banks don't appear interested in making loans to their small and sometimes highly risky businesses. But take a walk in the banker's shoes. If you were working with borrowed funds that had to be paid back upon demand, would you lend them to a business with a dubious ability to repay the loan? Of course not. So why should banks? They aren't built to lose money. They are, in the final analysis, running a business.

Another reason banks historically have not been fired up to lend money to small businesses is that small businesses typically request relatively small loans. The abundance-of-caution mode in which most banks operate means the analysis and disbursement of loans is a downright expensive process. The banker visits the company. Then visits again. Then reviews a loan proposal. He or she might even call on some of the business's customers or suppliers just to make sure the whole thing is for real. Then the banker submits a loan proposal to the credit committee. If it gets approved, the bank will create a truckload of documents, which the borrower will haggle over. The bank's lawyers will haggle back. Then the loan gets disbursed.

For the bank, it doesn't stop there. A loan officer will be assigned to the loan and will review the borrower's financial statements each quarter until the loan is paid off to make sure the company is not violating any covenants of the loan agreement.

The problem for small-business borrowers has been that the costs for the loan process were the same whether the borrower wanted $150,000 or $15 million. From the bank's perspective, if the costs are the same, it would rather distribute them over a larger loan, not a smaller one.

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This article was originally published in the November 1997 print edition of Entrepreneur with the headline: Loan Stars.

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