Banks are not venture capitalists
Despite the beliefs of many business owners, banks are not in the venture capital business and never will be. That’s why they are generally not interested in lending money to start-ups and are highly reluctant to lend on a long-term basis to provide working capital to the cash-strapped entrepreneur.
It’s also why venture capitalists are also known as “angel investors” – only someone with a direct line to heaven would lend money to a start-up!
Banks lend out your money
Unlike venture capital organisations, bankers do not lend out their own money – they lend out your money. And would you be happy for your bank to play the business start-up casino with your hard-earned money? I sure wouldn’t! And yet a new entrepreneur happily goes off to his local bank and asks for a large loan, because “I’ve got this great idea”. Unfortunately, great ideas are only worth anything if you’ve got the money to fund them.
Security, safety, solvency
Another reason why banks avoid any risk is that they have a reputation for security, safety and solvency to protect, and they safeguard this reputation at all costs. After all, their business depends on it. This is why banks are so careful to avoid any bad publicity, whether it’s a loan that has gone bad (another start-up bites the dust), or thefts from branches or ATMs, or fraud, including cyber fraud.
As a result, banks tend to be highly risk averse.The old saying that banks will lend you an umbrella while it’s sunny and snatch it back the moment a cloud appears, is pretty much the case. Business owners applying for a loan from a bank have to walk a narrow line between showing that they need the money and showing that they don’t really.
An overdraft is a fluctuating loan
Many business owners use their overdraft for working capital, but an overdraft is actually meant to be a fluctuating loan, ie the balance moves from debit into credit and back over time. Its purpose is to cover the time lapse between paying suppliers and receiving payments from customers. A non-fluctuating overdraft, ie one that stays in debit near the limit for a long period of time, is considered to be a problem and is a red light for a bank’s credit department.
A bank expects a business owner to have at least as much money in their business as the bank does. In fact, the bank relies on a calculation known as the “gearing ratio”.This calculates the proportion of outside funds, from suppliers and banks, to inside funds which the business owner has put into the business plus accumulated reserves, ie profit kept in the business.
Note: Customers/debtors are not included in this calculation as they are a source of short-term cash but not a source of long-term finance. In fact, if you don’t collect your debtors when due, you’re a source of finance for them.
So before you go looking for a loan or overdraft, calculate the gearing ratio for your own business as follows:
Funds owing to suppliers, banks, etc
Undistributed profits + shareholders’ loans
If this ratio is greater than 1:1, there’s more money in the business from outside lenders than from profits and shareholder’s loans. Then you’re going to have problems persuading the bank to lend you more money.
After all, why should they take all the business risk, and if the business fails, the business owner walks away with no loss? So banks want your own “skin in the game”. It also explains why banks will try to muster as much security as they possibly can, and only feel comfortable when the security is ten times the value of the loan.
This will be the case even if you are borrowing money to buy assets such as property or plant and machinery. Unless, of course, you are making good profits and can show that your weak gearing ratio will be rectified fairly soon.
So, if you’re short of working capital for your business, and you don’t have any cash yourself to invest, perhaps you should try the Shark Tank!
If you would like help with applying for finance from banks or venture capitalists, please send an email to email@example.com