Why Most Commercial Lenders Do Not Provide Loans To StartUp Businesses

Ronda Bauknight -Account Executive, Crest Capital - 09/08/2008

Why Most Commercial Lenders Do Not Provide Loans To StartUp BusinessesSome say it's the pinnacle of free enterprise. And pop culture lore is filled with tales of budding entrepreneurs with little more than a dream, ambition, and an empty garage. Yes, just start the business, get a loan, and get cracking on… wait a second, let's back up a bit.

Start up business funding is an often misunderstood concept. The old adage of getting "funding" for a startup business from a commercial lender is almost completely false. The truth is this – almost all lenders (including equipment financing companies) shy away from startups. Actually, lenders do more than shy away – lenders almost completely avoid them.

The reasons are simple – the truth is, roughly 80% of all (non-franchised) startup business will fail within five years. And although there's data out there that may dispute that fact like this report from the SBA citing a 56% failure rate (nevertheless confirming that more startups fail than succeed); that data is usually supplied by those that have an interest in people starting a business. In addition, the data that disputes the 80% number is almost always very recent.

This is actually the downside of statistics – almost any opinion or "fact" can be backed by a set of statistics somewhere. But to commercial lenders and equipment financing companies, the statistics that matter most are their own. In other words, many of these lenders have their own records that date back 10, 20, and even 50 years, and have learned the hard way that providing financing for startups is generally a bad idea.

The simple fact is this: according to the records of most commercial lenders and equipment financing companies, the 80% failure rate has held true for years. And since that number is culled directly from the personal records of commercial lenders and equipment financing companies, that's the number that matters.

Would you loan money when it is statistically more likely than not that you will not be repaid? The mortgage industry recently learned a profound lesson.

But I know somebody whose cousin's best friend's roommate got a startup loan…

Yes, somewhere out there, someone got a loan for a startup. It is (very) remotely possible. That's because there are perhaps five wholesale commercial funding sources that provide startup lending (quick note: most firms claiming to provide such are simply re-selling the five wholesaler's products. And here's the kicker – many of them would be better described as collection agencies disguised as commercial equipment finance companies.)

Here's what it generally takes to get approved by these sources:

• Almost perfect personal credit (not just good credit, but impeccable, absolutely spotless credit.)

• Personal guarantees and/or collateral from the principal(s), so the lender has some recourse (as the defunct business would be next to worthless.)

• Willingness to pay an above-market interest rate (typically equivalent to "high-interest" credit cards).

Herein lies the dilemma – someone with the above qualifications likely does not need funding or can't justify paying the associated high rate. It's somewhat of a catch-22, but that's the reality of it.

In order to maintain lower cost of capital, mainstream equipment finance companies must maintain default rates beneath say 3%. For a finance company to justify the double-digit risk of defaults associated with lending to start-ups, the rate paid by the borrowers successfully making payments must compensate.

But what about the SBA?

In addition, there's the Small Business Association. Contrary to popular belief, the SBA generally does not loan money itself, but instead acts as a guarantor for a bank loan. This makes the loan less risky for the bank, but most people are generally dismayed to discover that if they were going to have a hard time convincing a bank for a loan in the first place, the SBA may not be much help. In general terms, the SBA is more like that final push that turns a "maybe" into a "yes". And, as we've already pointed out, getting to a "maybe" is difficult.

Still, if you feel it can help, we do urge you to visit the SBA website.

However, let two years go by, and…

Now, there is good news here – once you reach two years, the numbers get a lot better. Equipment financing companies will be far more willing to speak with you after two years in business. This isn't any guarantee, of course, but two years in business is definitely more attractive than none.

Crest Capital

Crest Capital is a national equipment financing company that provides fast, easy, low-interest equipment financing and equipment leasing to small- and medium-sized (established) businesses.

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