According to some experts, it is harder for smaller businesses to get bank loans compared to larger firms. Why is that so? Find out in this Forbes.com article.
Several recent news reports suggest businesses are finding it easier to get bank loans or other forms of financing. That would be good news for the economy, because access to capital, especially access by privately held companies, is a component of job and economic growth.
Despite the attention stock market performance receives, researchers at the Pepperdine University have noted “the relationship between public stock returns and real economic activity has been shown to be weak, at best.” Instead, they say, “GDP growth in highly developed economies is significantly driven by the private sector and by entrepreneurial activity in particular.”
Many privately held businesses are looking to grow in 2014, but whether they do will be heavily influenced by their ability to finance that growth – either through earnings or outside sources.
“Nearly 89% of business owners report having the enthusiasm to execute growth strategies, yet just 46% report having the necessary financial resources to successfully execute growth strategies,” wrote Craig Everett, director of the Pepperdine Private Capital Markets Project and an assistant professor of finance, in the university’s 2014 Capital Markets Report.
More recently, the university’s survey of business owners shows that among the smallest businesses (those with less than $5 million in revenue) that sought a bank loan in the previous three months, 39% were successful, compared with 34% in a fall survey. Even so, it remains harder for smaller businesses to get bank loans than it does for larger firms, Everett said in an interview Friday.
A lot of times, business owners may get turned down and not know exactly why.
Mark Swanson, president of new markets and community affairs at Northside Bank in Adairsville, Georgia, has heard this often from business owners who have been turned down by other banks. “What I often hear from folks is, ‘Everybody’s told me no, but nobody’s ever told me why not,’” says Swanson, whose bank works to help clients understand any credit-related shortcomings.
Pepperdine’s research found the top reason banks rejected a business loan application was the quality of the applicant’s earnings or cash flow. Insufficient collateral and debt load were the next most common reasons, according to the banks surveyed.
“Quality of earnings” can mean different things to different lenders. But generally, having high-quality earnings means a company’s financial statements show stable, persistent and predictable earnings that are related to the core business. Similarly, the quality of a company’s cash flow refers to whether the cash generated by the business is largely driven by nonrecurring sources of cash or by something unusual, such as slowing payments to vendors.
“If earnings were higher this year but it’s because you had a big profit from a real estate deal and you’re a dry cleaner, that doesn’t count,” Everett said.
Smaller businesses often run into problems because their sales are generated by a small number of customers, or their earnings look weak. “A lot of small businesses, to be frank, really don’t manage their businesses in order to maximize earnings because they’re trying to minimize taxes, so they’ll have a lot of expenses,” Everett said. “But of course, that hurts them when they go to sell the business or get a loan.”
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While banks don’t always require collateral, they nearly always do for smaller businesses. The Pepperdine 2014 survey found that banks required collateral 100% of the time for loans of $1 million, but that percentage dropped to 63% for loans of $100 million. Similarly, personal guarantees are typically required for loans below $5 million, based on the survey.
If a business doesn’t have much in the way of equipment, buildings, inventory or accounts receivable, the lender will have fewer options for repayment of the loan, making the deal unattractive.
Of course, some businesses get into trouble borrowing money when they don’t really need it. Companies need to be cautious in seeking financing, according to Brian Hamilton, chairman of Sageworks, a financial information company.
In fact, a third of the nearly 1,000 business owners surveyed in Pepperdine’s 2014 Capital Markets Report said they have no outside financing. And while 37% didn’t try to raise capital in the last 12 months, those who did try found the most success tapping personal and business credit cards, friends and family, trade credit or equipment leasing (reporting 81% to 94% success rates for those financing categories).
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