Do banks lend to startups any more?
Probably not is the answer in the current climate.
Since the financial crisis, most banks do not lend to startups nor to most businesses they would have before the crisis hit.
However, there maybe the odd startup that’s got a business plan and sufficient equity behind it to warrant a bank to consider a loan. The plan has to forecast early cash flows and have significant equity funding.
Even in these circumstances, banks will probably ask for guarantees of some sort from the investors.
Here are the key points to consider before taking on a bank loan, whether you’re a start-up or established business and from the bank’s perspective.
1. Solid business plan – you must have a solid business plan with realistic financial projections including profit and loss account, cash flow forecasts and balance sheets. It makes the bank manager’s task easier to present a funding request to their internal credit committee and get it passed. They need to know how the bank will be repaid interest and principal.
2. Equity/net assets – the higher the equity and existing net assets, the easier it is for a bank to lend since it reduces their risk.
3. Risk – banks will always measure the risk of lending to a business from evaluating not only the business plan but also the state of the industry sector you’re in. After having incurred bad debts in property based lending, banks now focus more the business itself and the cashflows it would generate. The higher the risk perception, the higher the interest rate charged, if they lend at all.
4. Loan serviceability – free cashflows and EBITDA is all important and it’s not only the interest but the principal that has to be repaid over the repayment term. The business needs to be able to do both.
5. Tax efficiency of debt – most equity investors will want bank debt to work alongside their funds since it is very tax efficient and maximises their returns. Interest payments are tax allowable but in startups, there may not be sufficient taxable profits to take advantage of this.
6. Covenants – the terms banks impose for lending are called covenants and will include having a reasonably high ratio of EBITDA to the loan interest, security cover of asset value to the loan value, cash flow cover to debt servicing amount, restriction of equity holders taking out dividends until there is sufficient free cash flow, EBITDA to net borrowing ratio etc. There will be also other requirements such as regular monthly accounts which show all the covenants being met and regular meetings with management.
7. Security/collateral – it almost impossible except for the most established businesses to borrow funds without the bank requiring some sort of security/collateral. This will include a charge on the assets of the company through to personal guarantees from the directors/owners. It’s a risk that has to be considered carefully by business owners before signing over their personal assets!
8. Relationship – as with any funder, it’s important to have a good relationship with your bank manager and to have regular meetings to keep them informed of your company’s progress even if you never have to ask for bank funding. You never know when you may have to get some short-term funding be it an overdraft or short-term loan.
In my experience, the smaller business has a tougher time in obtaining bank funding and even in trying to establish a relationship with a bank manager since all the major banks seem to have skewed their business towards large businesses, which they perceive are more profitable for them.
It’s a short-term view since small businesses will grow in time and probably not need the funding as much when they get bigger!