Increase Business Funding Odds by Matching Business Life Cycle with Lender Risk Appetite

By on September 22, 2017
Eugene E. Valdez

By Eugene E. Valdez AKA The Loan Doctor™

In today’s confusing business lending industry small business loan applications are frequently turned down by Bankers and other lenders. One of the most common reasons which is rarely talked about, is what I call the “the mismatch between a company’s life cycle and the risk appetite of the approached lender”.

Let’s talk about a company’s life cycle first.  A company’s life cycle is analogous to a human being’s life cycle.

A humans life cycle is a newborn, (1 day to 12 months), toddler (13months –  3 years), young child (4 to 12years), teenager (13 to 18 Years), young adult (21 to 30 years),  middle age adult (31 to 50 years), and old adult (51 years plus).

A company’s life cycle is generally a startup (1 day to 15 months), very young (15 to 30 months), young (37 to 48 months), medium age (4 to 8 years), mature (9 to 15 years), and old (16 years plus).

The younger the company the more risky they are perceived by the lending community. Why? Because lenders know that it is very hard to create a viable business in the formative years.  Lenders know that at least 50% of all new startup businesses will fail within their first 5 years of operation.  Ouch!

The risk of lending money to a business diminishes over time due to several reasons but the primary one is the improved skill set of the CEO. Other reasons include but are not limited to; time it takes to create a brand or goodwill in the market, time it takes to break even and start earning a profit, time it takes to create good accounting systems, time it takes to create a decent balance sheet with satisfactory stockholder’s equity and time it takes to find and train good employees. Every year a CEO remains in business is proof that he or she knows what they are doing and that there is a market for their products and services.

Every lender has a different appetite for taking risk, risk defined as making a business loan (because it might not get paid back). The lenders that are willing to make a business loan to a company in the early stage of their life cycle (1 day to 36 months) will demand a higher interest rate. Lenders that are only interested in making business loans to medium age companies or older are more risk averse but concurrently they will charge lower interest rates.

So, Loan Doctor what does all this mean? Simple, if you want to increase your chances of getting business funding be aware of where you are in your business life cycle and only approach those lenders that are willing to lend to your “age group”.

Banks are very conservative lenders (they hate to take risk). This is due to the fact that they are regulated and because they primarily make business loans using their depositor’s money not their own (they have to be careful with “your money”, if you are one of their depositors).  Guess what age group they like to lend to? That’s right, young, medium age and mature. The exception, with an SBA guaranteed loan, Banks will lend to you earlier in your business life cycle but you must be profitable. However, not every bank makes SBA guaranteed loans, better do your research.

Because there are banks on every corner and they have million dollar advertising budgets, guess where every business owner goes to get that inexpensive business loan? That’s right, commercial banks. Now, you’re the owner of a startup or very young business and you stroll into Mega First Bank seeking a $150k loan to take your business “to the next level”. Anybody guess what happens? Declined, Why? Because of a mismatch between the company’s inherent stage risk and the bank’s risk tolerance.

Listed below are stages of a company’s business life cycle and those lenders that are willing to lend to those stages. This information is fairly general and there are always exceptions. This list is not definitive either. Other new sources exist, (“crowd funding”, et.al) but I have space limitations.

  • Startups- Private Investors, 401K savings, credit cards, equipment leasing cos. factors, Home Equity Lenders, Bank of MAD, (Mom & Dad), YOD (your own dough), family or longtime friends, (very long). Micro loans.
  • Very Young- Specialty non- bank lenders, (affiliated with the SBA); commercial finance companies; factors; Bank Loans with major credit enhancements, i.e.; SBA guarantee, State guarantee, California Capital Program; PO Financing; specialty equipment lenders.
  • Young- Conventional Bank loans, Mezzanine Financing
  • Medium Age- Conventional Bank Loans
  • Mature & Old- Conventional Bank loans, insurance companies

Remember the matching principle!

Eugene Valdez is a 40-year veteran of business/financial management and owner of The Loan Doctor, a full service business loan consulting firm based in Upland. He can be reached at evaldez@theloandoctor.loans.