In the Balance

If you're like most entrepreneurs, you probably assume that when you're seeking a loan, banks will turn you down because your company is too small. Even if you do get a loan, you may expect banks to set stricter loan terms for you than they would for larger firms. But recent studies show that the size of your company is not the most significant issue in setting bank loan terms.

In "Do Banks Price Owner-Manager Agency Costs? An Examination of Small Business Borrowing" (Journal of Small Business Management, October 2002), James C. Brau looks at 463 small corporations and whether the banks they borrowed from packaged their loans differently because of their smaller size. Surprisingly, the banks did not charge a premium in the interest rate due to size, nor did they require additional collateral because the company was smaller. Instead, the interest rate charged to smaller firms was affected by four factors: the length of the firm's longest prior banking relationship, the number of prior banking relationships, the length of time the firm has been in business, and the level of annual sales. Similarly, the amount of collateral required was closely linked to the number of prior banking relationships and the overall debt position of the company.

What can you learn from this? In seeking a bank loan, focus on developing and maintaining solid banking relationships. Work with several different banks-perhaps one for leasing, another for financing, etc. Working closely with many banks, along with reliable sales, will reduce the perception that your small company is a borrowing risk.

David Newton is a professor of entrepreneurial finance at Westmont College in Santa Barbara, California. For more journal summaries, visit www.techknowledgepoint.com.