New Business Ideas: How to Determine the Contenders from the Pretenders

A client sits across your desk and pours out a business idea that he needs financing for.  At this point, you don’t know if his idea is destined for failure or will be the next success.  After all, most successful businesses once started with someone with an idea sitting across the desk of a loan originator requesting a loan to get started or to go to the next level. 

Commercial and ag lending is humbling.  You can review the facts and make the best judgment possible on the loan request, but you never know if it was a good decision until much later.  The only good loans are those that eventually pay off.  So, hindsight is always 20-20, but there are some signs you can look for to determine if the idea presented to you is worth an investment in the form of a loan from your institution or not. 

Experience and Education.  Does the customer have experience in the business field that he wants a loan?  Borrowers who have the training and work experience in the field they will be operating in have an advantage compared to those who do not.  You would not want to give a loan to someone to open a medical clinic that does not have the background to operate the business.  This principle will apply to whatever business you are looking at. 

Not only do you need to look at the background of the borrower in front of you, you need to look at the experience and training of his key personnel compared to the skills required to make the business work.  For example, if you had a few good cooks with only culinary skills who want to open a restaurant, there may be some challenges since they do not understand such things like managing staff, running the “front of the house,” and optimizing cash flow.

Equity.  Successful business owners have “skin in the game.”  This can come from cash, property, or equipment they are bringing into the business.  You should run from any loan request where the borrower is expecting you to provide all the proceeds for the project and there is no investment from the borrower.  If the borrower’s idea is good enough, the request is for a venture capitalist not a credit union.

Earnings.  Good loan requests on established businesses will have a history of earnings that can support the request.  The challenge is what do you do when you are dealing with a new business venture or a huge increase in the business where there is either no history or not substantial history to support the request? 

A good lender will look for mitigating factors to combat this risk.  How reasonable is it that the business will succeed?  Does the borrower have other source of income to sustain his life while the business is in its early stages?  Can you look at some option like a government guarantee to reduce your credit union’s exposure?

Ease.  I call this the “ease test.”  Pretend that the only source of loan money was from your dear, wonderful grandmother.  She has worked her entire life for her meager nest egg and now is relying on you for investment advice.  If you took her money and lent it to your borrower, how easy would it be to explain to her your lending decision?  Would she be proud of your action?  Or, would you have to spin a verbal tale to her to justify your actions?  If you want to be a little more scared, you should be prepared to explain your decision to your management or to your regulator. 

Remember lending is more of an art than a science.  I cannot tell you that every request you have that meets these tests will end up as a good loan.  I also cannot tell you that if a request was lacking in an area or two if it will turn out to a problem loan.  I can tell you that lending involves looking at the overall picture and applying a good dose of common sense.