Monday, 31 March 2014

Billy’s Twentieth Law -- Banking Paradox Two: Just because your business is bankable, doesn’t make it viable!

The surest way to ruin a man who doesn't know how to handle money is to give him some.
·         George Bernard Shaw
Last week, we looked at banks’ lending criteria.  This week, we look at the reality of a small business loans.  Before the nineties, a business loan was scrutinised by a business banker.  This is a time consuming process performed by a highly skilled individual.  (Or so business bankers would have you believe!)  Wells Fargo Bank in the Unites States made an interesting observation.  The best predictive indicator for the repayment of a small business loan was not the business plan, but rather the credit worthiness of the prospective business owner.  People who managed their personal finances well were more likely to repay their debts than those who did not.  
This created an interesting dynamic in the small business lending arena.  Personal credit history replaced the brilliance of a commercial credit officer.  Personal lending criteria replaced business-lending criteria when granting smaller loans. 
When this concept first came to Canada, it was revolutionary in banking circles.  Banks could speed up their responses to smaller business loans simply because it is easier and faster to do a credit check than to analyse a business plan.  I remember that the first loans were up to $35,000.  BMO (if memory serves me) increased this to $50,000. 
Over the years, this seems to have worked in Canada, as the loans are getting quite large before a commercial credit officer takes over your account.  The refusal rates were lower, default rates dropped and the approval process was faster and simpler.  The bank did not require a time consuming business plan, which includes the cash flow forecast.  Entrepreneurs were happy and the banks were happy. 
There is one problem with this situation.  Many businesses are financed without the scrutiny that used to accompany a business loan application.  The banks do not distinguish between a loan repaid with the proceeds of the business, the contributions of a willing spouse or even the redemption of RRSP’s, investments or sale of the house.  The bank just knows that it was repaid for the loan.
In our business, we have seen many people scrambling to repay lenders using such sources.  We have seen marriages come under huge financial stress, as one partner finances a business that takes all of the other partner’s time and efforts, as the enterprise sinks deeper and deeper into the financial abyss. 
I cannot say that I blame financial institutions.  Analysing a business proposal takes time and expertise.  The cost of administering a small loan, given the small margins the bank receives on a smaller loan leads to such banking policies.  Many people however are unaware of this.  Some people see bank financing as an endorsement of the business or the concept.
Unfortunately, I don’t have an answer.  I don’t think it is realistic to hold the bank responsible for the future of an enterprise, yet most people have no idea how to objectively evaluate a business, never mind a business concept. 
So, as they say, Caveat Emptor.  However, let this lesson be to you.  Your financial institution really wants you to succeed, however; in the final analysis, they want repayment even more.

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