To Default Or Not To Default
To Default Or Not To Default
When it comes to loaning businesses money – whether for a new enterprise or an expansion – there are some definite “money in the bank” bets. There are also some that carry a bit more default risk.
The TCBN asked a handful of local commercial lenders to share some insight into good indicators that a loan – and subsequently a business – will likely be a success, what industries bankers consider “safe” today as well as those that tend to be on the risky side.
Senior Vice President/Commercial Loans, Lake Michigan Credit Union
Factors that most dictate whether a business (loan) will succeed or fail: Properly capitalized, experience, proper planning (a well thought-out business plan)
“Safer bet” industries: Manufacturing and wholesaling. Why? Tend to have been in business longer and have a track record. Tend to have collateral and a strong customer base.
“Riskier” industries: Restaurants, golf courses/resorts. Why? Restaurants tend to have less collateral, a “fickle” customer base and heavy competition. Golf courses/resorts are very capital intensive, have single purpose collateral, are weather dependent and have a lot of competition. The thing to remember is that there are always exceptions to the rule. You can have good or bad “operators” in any industry segment.
Most common obstacle today for a new business trying to get a loan: Having the necessary capital to get it started. It’s not only the down payment but the capital to get through a business cycle.
Biggest “no brainer investment”: Any loan where the borrowers are borrowing against their own cash/securities falls into that category.
Traverse City Market President, First National Bank of America
Factors that most dictate whether a business (loan) will succeed or fail:
A loan may go bad because the lender may have structured it poorly in the first place or made the terms too loose then came back on the borrower with tighter covenants or terms which made doing business more restrictive. Most successful businesses make their banks happy; they operate within the confines of their debt.
For a business to succeed: Determination and the entrepreneurial spirit – a high character individual who isn’t afraid to make sacrifices and see things to the end; adequate liquidity – every business has different cash needs but a business that is undercapitalized is doomed from the start.
For a loan to succeed: Cash flow; whatever the business is, the business needs to generate positive cash flow after the owners are able to earn a return for their own pockets; repayment terms that match the earnings/cash flow of the business.
“Safer bet” industries: Multi-family housing. Why? In this region and in other parts of Michigan, there is a lack of affordable housing projects. Proven management companies and landlords are a fairly safe bet right now. Also, credit tenant retail. These are large retailers that have large balance sheets and the ability to pay rent. Many of these loans go to life insurance companies or to the CMBS (commercial mortgage-baked security) market.
“Riskier” industries: Historically, restaurants. However, in the local market the downtown hospitality industry is fairly buffered from the national averages. Also, small-scale retail (ie. hardware stores, bookstores, knick-knack stores) – these companies have a tough time with staying power when they don’t have a pricing advantage and they do not get rewarded for sitting on inventory.
Most common obstacle today for a new business trying to get a loan: Lack of understanding of what their actual needs are. Most businesses look at the initial cost of getting the doors open but rarely take into account how long it will take to generate revenue and collect money. Many new businesses underestimate how much capital (debt or equity) it will actually take to grow their business and as a result many fail because of lack of capital.
Mitchell Blue, Dan Druskovich
Senior vice presidents, commercial lending, Traverse City State Bank
(CEO Connie Deneweth also contributed)
Factors that most dictate whether a business (loan) will succeed or fail: Experience in the industry, capitalization of the company, level of owner involvement, poor accounting skills, poor management skills.
“Safer bet” industries: Non-cash businesses are safer than cash businesses; non-perishable businesses are safer than ones selling perishable items; non-saturated markets are safer businesses.
“Riskier” industries: Restaurants. According to the National Restaurant Association, 30 percent of new restaurants fail in the first year, and of those that survive another 30 percent close in the next two. Other reasons why restaurants are riskier is that multiple skillsets are necessary to appropriately manage them, they require the owner to be on site most of the time, they are trendy and seasonal. Other riskier industries include retail and logging.
The failure rate of family businesses transferred to the third generation is 87 percent, according to the Family Firm Institute. The second or third generation doesn’t have the background or the experience to make good management decisions. Parents mistake education for experience. No matter how smart, experience trumps education. The kids also generally lack “scratch & claw” drive.
Most common obstacle today for a new business trying to get a loan: Lack of capital (down payment & reserves).
“Biggest no brainer investment”: 1) Cash secured deal; 2) Many super sweet success stories come from owners selling their company for an excellent price to a large corporate entity and then buying it back from the same company for cents on the dollar years later. There are several local examples of these deals. These are almost always a sure winner because the old owners know exactly what it takes to succeed in that business and their leverage is much lower the second time around.
First VP & Senior Lender, Commercial Loans, Honor Bank
Factors that most dictate whether a business (loan) will succeed or fail: Management, capital or lack of capital, global economic factors, management/mismanagement of debt.
“Safer bet” industries: Municipal lending; medical
“Riskier” industries: Construction/development/investment real estate lending; start-ups, even more so on retail and restaurant start-ups. The construction industry has gotten less risky over the past few years but is still inherently one of the riskiest areas to lend. Single family home construction has one of the highest failure rates among start-ups as well. Start-ups come with the inherent risk of the unknown. However, this risk can often be mitigated with a government guarantee from the Small Business Administration. Restaurants have one of the highest failure rates among businesses. The retail market is dominated by big box stores and national supermarket chains.
Most common obstacle today for a new business trying to get a loan: Having a viable business plan with data to back up their projections to show the business will really work.
“Biggest no brainer investment”: I don’t know that there are “no brainers” in banking, at least in lending. It’s a risk business inherently.