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In the Balance

Learn the factors banks really weigh when setting loan terms.

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This story appears in the July 2003 issue of Entrepreneur. Subscribe »

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

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

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