Two Sides to the Same Picture
I spend a lot of my time working with entrepreneurs and bankers. These two groups don’t always have the easiest time communicating, so I sometimes find myself in the position of translator. These communication problems predate the current difficult lending environment, and I expect will still be around long after the credit markets loosen up. They reflect the fact that the two groups have very different views of several very basic issues.
Most entrepreneurs view their latest opportunity as a sure thing. They have played the scenario through in their minds dozens of times, tweaking it each time to improve it. There may not be any product, any customers or any employees yet, but the entrepreneur views the return as potentially infinite and the risk as negligible.
The banker carefully considers all of the risks that the entrepreneur has discounted, while understanding that his upside is limited. As a banker told me many years ago, “The best that I can hope for is that I will get repaid, on time, with interest. I am not an owner.”
These two views are unlikely to be reconciled. This means that the entrepreneur needs to understand that there are opportunities that are bankable deals and others that will require non-bank financing sources. I have seen many business owners waste a lot of time and money taking a non-bankable deal from bank to bank, only to get the same “NO” every time.
Ask an entrepreneur how much his company makes and he may say “$1 million dollars.” Look at last year’s income statement for the company, however, and you may see $800,000 of net income. I guaranty you that the banker will see $800,000, and will be uncomfortable with the discrepancy. In this case, the reason for the difference is that last year the company had a large bad debt, or a big inventory loss or a project that went bust to the tune of $200,000.
To the entrepreneur, that loss is in the past, and being a forward thinker it is irrelevant to him. He has already ”normalized” the income and assumes the rest of the world does the same. The banker with a historical, or backward, orientation starts by assuming that $800,000 is the normal level of income and starts her analysis from there.
The lesson here for entrepreneurs is that one time or unusual items (both positive and negative) need to be highlighted and explained in detail to help allow the banker to move forward from the same starting point as the entrepreneur. Don’t assume everyone understands the business as well as you do.
I’ll ask an entrepreneur how much debt his company has and he may reply, “We are debt free!” With that information, I may start thinking that we will easily be able to get bank financing for a new expansion project. But upon further review, I find that he has borrowed money for a real estate venture, owns another company that is heavily indebted, and has guaranteed his brother-in-law’s mortgage.
When asked about these debts, he replies, “But they aren’t related to this business!”
Entrepreneurs are masters of compartmentalizing, or putting things in different buckets. Bankers take a comprehensive view of a borrower’s overall credit situation. Changes in accounting rules also make it more difficult for companies to ignore so-called “off balance sheet” liabilities. Since Enron, transparency in financial reporting is the rule.
The take away here for entrepreneurs is while it may make good sense to compartmentalize different business opportunities for tax or liability purposes, don’t think that you will be able to compartmentalize your debts. They will all be on the table.
If you need help translating what your banker is saying, feel free to contact Doug Jones at Fahrenheit Finance at firstname.lastname@example.org
Director, Fahrenheit Finance