Empathy is an essential characteristic of a successful business owner. In all aspects of business development—whether is customer relations, labor management, or seeking a strategic new business partnership—assuming the viewpoint of the person across from you is an invaluable practice.
One group of people that most entrepreneurs typically fail to empathize with is bank lenders. This is not surprising, since bankers and entrepreneurs tend to have fundamentally different personalities.
As entrepreneurs, we always think bankers are conservative geeks–boring guys who don’t want to take risks. Entrepreneurs, however, are forward thinkers that shirk conventional wisdom and are willing to pivot their business and operate without a well-defined monetization model for extended periods of time.
But if you ran a bank, you’d understand that losing money is simply not an option.
Banks are the most highly leveraged institutions in the economic system. They operate on extremely slim margins—less than 1% after you account for defaulted loans, interest to depositors, and operating costs—and their ability to assume risk is far lower than that of an enterprising young business.
This may seem obvious, but eliminating the adversarial entrepreneur-banker relationship is key to getting the loan needed to grow your small business.
Risks are an inherent part of any loan or investment, but if you want to know how to put a banker’s worries at ease and score that loan, you’ll need to effectively answer these two questions.
1. Does your company have reliable cash flow?
I remember being 23 and thinking, “Gee, I’ve been making money for six months,” and feeling financially secure. But that’s like saying you’re a great college student because you did well in one semester. You need a couple of years of good grades before you can claim to be a model student–and the same principle applies to your business.
If you want a loan, you need to have tax returns and income statements from at least two years that demonstrate cash flow. Banks don’t invest in start-ups. So realize that if your business is younger than that, a bank loan is not yet a viable option. (Projections mean little to a banker.)
As a business owner, you should strive to have your company’s ratio of cash flow to debt service be at least 3:1, preferably 4:1. But banks will also look at your global debt service ratio—the ratio of your company’s revenue to your combined business and personal expenses. This number can be slightly lower, around 2:1 to 3:1, in order to alleviate a banker’s worries.
It’s important to know your personal credit history and other outstanding loan payments (e.g. student loans) will be factored into your global debt service ratio. At the end of the day, a bank is lending money to you, not your business.
2. Do you have enough collateral?
Even when investing in a small business seems lucrative to a banker, they will always plan for the unfortunate event that the loan goes bad. In this case, they will resort to a “secondary source of repayment,” company assets that can be sold to recoup lending debt.
Now, banks don’t always need collateral—and as a business owner, you should never enter into a loan arrangement that you don’t believe you can pay back in time.
Collateral always helps, though. Your business itself does not have value, but the physical assets you or your business owns can help you secure a loan. A bank wants to have something tangible—real estate, inventory, or appliances—that it can sell, or accounts receivable that they can collect, if a business defaults.
The thought of a bank collecting collateral on a defaulted loan only serves to reinforce the image of banks as merciless, uncaring entities. So know that collateral is the last thing a bank wants; it’s terrible for a bank’s reputation and more costly than receiving interest on the original loan.
People are always intimidated by what they don’t know. In business, most company owners are scared of bankers because they simply don’t know what bankers want and how they think.
During the recession, banks pulled back from lending. But small businesses were partially guilty for the lack of lending as well. Uncertainty in the banking system made small business owners hesitant to apply for a loan.
Banks are loosening up now, though, and they need business owners willing to seek them out.
But when you do, make sure you bring along all the necessary documents (tax returns, financial statements, revenue projections, a lending statement, etc.). And most importantly, bring your empathy. –As told to John McDermott