Posts Tagged bank loans
Most small businesses start with a business plan to get financing for a venture, but entrepreneurs prefer managing risk through effectuation. Effectuation entails entrepreneurial control over what an entrepreneur can do to achieve a wanted result when the means to that result involves taking an uncertain action. The effectual thinker takes action toward an imagined state incapable of continuous planning because the entrepreneur is uncertain about the result of the action (Gabrielsson & Politis, 2011; Read & Sarasvathy, 2005; Sarasvathy, 2001; Sarasvathy & Dew, 2005).
Entrepreneurs create business plans to achieve early financing and develop plans like they understand the outcome of their actions, but this often is not the case. Entrepreneurs performance typically is significantly off from early plans not because of bad planning, but because of uncertain actions taken toward imagined outcomes. Planning is valid when actions are certain to produce a known result.
Financiers fail to recognize this disconnect, and conventional planning does not fit when an entrepreneur works toward an imagined outcome. Financial planners rely on existing business models and not newly created ones. Not until the entrepreneur perfects the model can planning have true substance in predicting a wanted result.
Financial planning done for business plans at best presents a plan conforming to existing conditions. When an entrepreneur wants to create a new market or product conditions do not yet exist to support such plans. Such conditions cause financiers to rely on risky projections.
This disconnect raises a question about how to evaluate a venture without a financial track record when future actions are dubious. What can an entrepreneur do to convince a financier of the merits of the venture when financial planning projections are so far-off from true results? I want to know your thoughts. Do you want to learn more?
Gabrielsson, J., & Politis, D. (2011). Career motives and entrepreneurial decision-making: examining preferences for causal and effectual logics in the early stage of new ventures. Small Business Economics, 36(3), 281-298. doi: 10.1007/s11187-009-9217-3
Read, S., & Sarasvathy, S. D. (2005). Knowing what to do and doing what you know: Effectuation as a form of entrepreneurial expertise. Journal of Private Equity, 9(1), 45-62. Retrieved from http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=19164962&site=bsi-live
Sarasvathy, S. D. (2001). Causation and effectuation: Toward a theoretical shift from economic inevitability to entrepreneurial contingency. Academy of Management. The Academy of Management Review, 26(2), 243. Retrieved from http://proquest.umi.com/pqdweb?did=72362644&Fmt=7&clientId=13118&RQT=309&VName=PQD
Sarasvathy, S. D., & Dew, N. (2005). New market creation through transformation. Journal of Evolutionary Economics, 15(5), 533-565. doi: 10.1007/s00191-005-0264-x
I read a blog post today about how banks have started to lend to small business again. Considering the bad treatment banks have given their customers I wonder how they will treat small businesses after cutting off lines of credit and other lending to them during the financial crisis. I suggest considering the credit union as an alternative to a bank for small business lending. Personally, I like getting treated as a person instead of as a commodity and credit unions have many advantages. I just opened an account with a credit union and I found the I received much better treatment and the credit union valued not just my business, but me as a person.
I remember an SBA loan I had with a small bank that a larger bank later took over. For several years the bank and I had a good relationship. One day I received a notice the larger bank had bought the bank and the new bank no longer wanted SBA loans as part of its business. The new management made it difficult to preserve the good relationship by charging new fees for everything imaginable. A few years into the recent financial crisis I saw this bank on a list of the banks the Fed had shut down.
Because small business financing sources have evaporated during the global recession, small business should consider using credit unions. Credit union unlike small banks are cooperative nonprofit organizations. As nonprofit organizations credit unions have an exemption from tax resulting in lower costs allowing them more latitude in making loans. Credit unions also enjoy lower costs from volunteer labor and employer sponsorship giving them the ability to offer lower rates. Besides offering small business loans, credit unions also offer other products like credit cards and car loans (Feinberg & Rahman, 2006).
The trend is for large banks to buy smaller banks especially in larger markets. This trend has resulted in less lending to small businesses causing a need for alternative funding sources like credit unions to service small businesses. Consolidating small banks has created less of an interest in small business lending. The lack of interest stems from the difficulty large banks have dealing with soft data, the more hierarchical bank’s need for more approvals, and lower credit supplies by the larger organization (Ely & Robinson, 2009).
Oriz-Molina and Penas (2008) found one way to mitigate opaque risk from small business is to shorten loan terms to watch the progress of small businesses. The more conventional approach is to want greater collateral over a longer term. Credit unions also have the ability to gain a better understanding of owners’ personal wealth. Although credit unions can focus on better addressing opaque risks using these approaches, larger banks often rely on credit scoring to approve small business loans to achieve a competitive advantage (Immergluck & Smith, 2003).
Despite the ability of larger banks to gain a competitive advantage in lending to small business, credit unions are closer to small business customers and able to forge better relations. Large banks have shown poor behavior in recent years making them less attractive than more personal, smaller thrift institutions. For example, banks have added new fees and restricted lending to only the strongest small businesses. Improved relations with small businesses promotes long-term relations despite shorter lending terms.
Consolidating small community banks into larger banks has caused banks to become less personal and more selective. Credit unions fill a social gap in the market because of consolidation of these community banks and the cost advantage they have from the nonprofit status. Credit unions can expand from solely personal to more commercial lending to fill this gap.
What sources have you considered for your business in achieving financing? Are credit unions part of the mix? Do you want to know more about the value of commercial lending by credit unions? Find out more about how you can benefit.
Ely, D. P., & Robinson, K. J. (2009). Credit unions and small business lending. Journal of Financial Services Research, 35(1), 53-80. doi: 10.1007/s10693-008-0038-3
Feinberg, R. M., & Rahman, A. F. M. A. (2006). Are credit unions just small banks? Determinants of loan rates in local consumer lending markets Eastern Economic Journal, 32(4), 647-659. doi: 1241333261; 35361511; 11879; EEJ; INNNEEJ0000065491
Immergluck, D., & Smith, G. (2003). How changes in small business lending affect firms in low- and moderate-income neighborhoods. Journal of Developmental Entrepreneurship, 8(2), 153-175. doi: 502848551; 8351081; 38473; DVEN; INODDVEN0000469300
Ortiz-Molina, H., & Penas, M. F. (2008). Lending to small businesses: the role of loan maturity in addressing information problems. Small Business Economics, 30(4), 361-383. doi: 10.1007/s11187-007-9053-2
Finding financing for a small business is like playing Where’s Waldo. Where’s Waldo is a game in which a player looks for a funny guy in a red-striped shirt and stocking cap in a maze. Waldo blends into the crowd and is difficult to find.
Small businesses look to find a source of financing among a maze of potential financiers and hazards. Financing can include angel investors, venture capitalists, banks, and other sources of equity and debt. Ma and Gui (2010) classified direct small business financing in the United States into venture capital and securities financing. Ma and Gui explained indirect financing comes from commercial bank loans. Some commercial bank loans have a government guarantee from the Small Business Administration. Mezzanine financing is another hybrid source of financing valuable because a company can treat much of it as equity even though it combines features of debt and equity (Silbernagel, Vaitkunas, & Giddy, n. d.). The maze is difficult to navigate because the terms differ from one source to another. The small business should target equity financing whenever possible because debt financing is more risky. Micro financing and crowd funding are some new entries to the maze, but an old favorite is bootstrapping.
A person playing Where’s Waldo has to examine the maze with great scrutiny to find Waldo blending in to the crowd. Waldo is a friendly guy, but is crafty in making himself inconspicuous among the crowd. Waldo may have hidden motives in avoiding making himself obvious.
A small business needs to have an awareness of the hidden motives different financiers may have. Some financiers use convertible features to gain control of a company. The small business should have an awareness of these features to prevent a takeover. Small business founders work hard to find a working model for their business and should protect themselves from possible takeovers by reviewing the terms of the financing. Protecting a controlling interest in the firm is a critical role for a small business founder to keep control and avoid the board from firing him.
When one finds Waldo, the game is over and the player can start a new puzzle. A small business founder looking for the right financing locates it the search is over, but he must remember to make sure the terms allow for keeping control of the company.
What sources of financing have you considered? Want to learn more about small business financing and how to preserve a controlling interest? Learn more.
Ma, J., & Gui, J. (2010). Study on the small and middle enterprises financing mode in financial crisis. International Business Research, 3(1), 76-79. doi: 2225515451; 56706961; 137934; NBRS; INNNNBRS0000568443
Silbernagel, C., Vaitkunas, D., & Giddy, I. (n. d.). Mezzanine Finance, from http://pages.stern.nyu.edu/~igiddy/articles/Mezzanine_Finance_Explained.pdf
I often see bankers trying to lure small business owners into letting them help manage their cash flows. Although managing cash flows is critical for the small business owner, I question the value of going to a banker for help. In my experience, many bankers only have banking experience and little other tangible business experience. Banks concern themselves with cash flows mainly to ensure customers produce enough funds to pay the bank back. Is this approach enough to create enough cash to run your business?
Banks do not provide services without some form of compensation and may charge fees for managing cash flows. Banks often have no understanding of your business and what it takes to increase cash because all they understand is that you must sell more without understanding the tactics it takes to make more sales. Many times banks simply focus on cutting costs without considering new ways to raise revenues. Is this the approach you need?
My advice to the small business owner is to look at your own cash flows daily. Looking at your own cash flows will help understand where to increase revenues and where to cut costs. The business owner is the person who needs to decide how to increase cash and how to cut it not some outside party with little experience in your business. A business owner can look at the environment in which the company works and do some scanning to see what best fits the company’s model.
A company that does need help should employ a coach or an analyst to help design a procedure for the owner to make his own daily evaluation of cash flows. A coach or an analyst can also help the small business owner asked the right questions about what to add to improve revenues and what to cut to decrease costs. Experience and education are key ingredients in deciding what revenues to improve and what costs to cut. A good consultant is worth his or her weight in gold in helping the small business understand how to produce enough cash flows to keep a profitable business.
In my view, a good coach or consultant is there to guide you and help you develop the experience you need to make intelligent cash flow decisions. Yes a good coach or consultant comes with a cost, but the cost pays for itself because the small business owner benefits from learning how to manage his or her own cash flow. Do you want to learn more? Do you think you can get the same service from your banker?
I remember when I started my first business how frustrated I became when everyone wanted to reject my business plan. Everyone wanted to say, “Your plan is not good enough, “You can’t do that,” “Your numbers don’t add up,” or some other lame reason to reject me. I don’t even remember them all. The average person might just say, “I’ve had enough,” I tried,” “I give up,” or “Maybe everyone else is right.” I thought who are these people who do not know the first thing about my business to make these disparaging remarks. Do these people even care?
After finally getting the loan I needed to start my business, these comments didn’t even make a difference to me. I was free and I could put my focus on my passion. Now is the time to prove the naysayers wrong!
Unlike some I am not a quitter. Think about it! Would you rather work with someone who is persistent, diligent, determined, vigilant, and deliberate or would you prefer to work with someone who quits? Do you want someone who helps take a project to reach its final conclusion or someone who simply walks away without giving it the effort it deserves?
I know what I prefer, and it’s not quitting. I know I have it in my DNA to never to give up. I yearn to achieve what I set out to achieve and do not let little setbacks stand in my way. I am energized by learning more about my business so I can serve my customers better. For me the fun is in getting to my goal, not settling into a comfortable position. If you want a comfortable position get a job. What I do is not a job; it’s an eternal fire I need to put out.
If you don’t have the fire, I suggest quitting now. Do you want to learn more?
I theorize that innovation works best in a small firm because different goals exist than in the larger firm. Some justification exists in the literature supporting this theory. Large firms place improving shareholder value through stock price appreciation ahead of discovery of innovative solutions (Crochetiere, 2011). Corporate managers concern themselves with shareholder wealth enhancement and emphasize short-term profitability.
Founders of small innovative firms put products and services first ahead of profitability. Steve Jobs offers a good example with his obsession to create computers for students. Job’s passion put product ahead of profits (Deutschman, 2000). Jobs exited from Apple when the company put the focus on shareholder wealth instead of perfecting the product (Levy, 2011).
Small business owners starting a company should consider their goal. A founder should consider if the motivation is to cash out or extinguish a burning fire to solve a problem with a new product or innovative service. A firm that opts for the latter should avoid acquisition by larger firms and keep it simple.
Crochetiere (2011) found evidence suggesting large firms produce fewer patents and innovations than smaller firms. Larger firms not only produce fewer patents, but lose stakeholders and their acquisitions result in greater variability in stock prices.
What is the goal for innovation in your business? If you need help planning your strategy click here!
Crochetiere, B. (2011). Transcending technological innovation: The impact of acquisitions on entrepreneurial technical organizations. (D.B.A. 3482298), Walden University, United States — Minnesota. Retrieved from http://search.proquest.com/docview/909085620?accountid=35812 ProQuest Dissertations & Theses (PQDT) database.
Deutschman, A. (2000). The second coming of Steve Jobs. New York, NY: Random House.
Levy, S. (2011). The revolution according to Steve Jobs. Wired. Retrieved from http://www.wired.com/magazine/2011/11/ff_stevejobs/all/1
Often people who want to start a small business immediately think of going to the bank for a loan. Unfortunately, the bank is not the best place to start. A business founder should consider informal financing sources and trade credit first. Studies have shown that informal financing improves a firms efficiency and performance because it improves return on assets. Informal sources of finance and trade credit can relieve cash flow anxiety and improve a private firm’s ability to reinvest net income (Su & Sun, 2011).
Bank financing increases cash flow tensions and takes the focus off growth and achieving efficiency. New firms also find less access to more formal sources of financing such as angel investors and venture capitalists. Su and Sun (2011) explained “informal financing and trade credit are the life-blood of private firms” (p. 398). In countries like China interest rates on informal sources of finance are not subject to regulation, and financing is not rationed by imposing higher interest rates. More relaxed relationships with informal lenders promotes competitive advantage.
Why start at the bank? Want to get started? Get $115 off on your business plan. Click here.
Su, J., & Sun, Y. (2011). Informal finance, trade credit and private firm performance. Nankai Business Review International, 2(4), 383-400. doi: 10.1108/20408741111178816