The following is an interview with Kim Stewart, SVP, Working Capital Solutions Advisor, BB&T for my Entrepreneurial Feasibility Analysis graduate course. Kim and I became acquainted in 2016. We discuss entrepreneurial financing.
Q. What is your role in banking as it relates to “investment” in small business?
A. I work in an area of the bank that provides various solutions to companies that need working capital financing to support their on-going business activity or growth.
Q. What role do you now or have you in the past played in determining financing support for an entrepreneurial venture?
A. I have in the past worked in a banking environment where we would provide working capital lines of credit down to a minimum of $1MM, which may likely be too high of a minimum for many entrepreneurs that are “start-up” ventures, but I was still able to work with many entrepreneurial companies. I am involved in working with the customers on the front end in determining what their financing need is and how best to structure a financing solution.
Q. How is bank “investment” in small business different than, say angel investment? Does a bank often provide seed or startup investment?
A. It is inaccurate to say that banks invest in small business in the normal course of their operations. Providing financing is not investing, and for that reason, banks have to be stringent about identifying the risks and appropriately mitigating those risks. Traditional banks are paid a reasonable rate of interest for the use of funds as opposed to having an opportunity to participate in the upside of a business venture. There are ways that banks can work through the Small Business Association (SBA) to provide funding for a start-up investment, and there may be banks that are willing to take more risks on start-up ventures, but they would generally be interested in opportunities where the entrepreneur had a track record of successful ventures and had some capital to invest in the venture.
Q. How might bank financing requirements of an entrepreneurial venture differ from an angel investor?
A. Both are going to underwrite the risk of success or failure of the venture and the likelihood of being repaid in the event the venture fails, but an angel investor is not bound by regulation regarding the amount of interest and fees that they can charge and will often require some percentage of ownership of the company as a part of the investment, therefore they have the ability to get compensated for taking a higher level of risk.
Underwriting the risk involved in providing credit to a business will include considering primary and secondary sources of repayment. The primary source of repayment is generally cash flow generated by the operations of the company and to underwrite this involves a complete knowledge and understanding of the company’s operations, the industry in which they operate, the capital required to operate the business, financial analysis of historical operations, management strengths, ownership structure, etc. The secondary sources of repayment are generally liquidation of collateral and financial support provided by guarantors. These sources would also need to be fully reviewed to assess how much support they are capable of providing in the event the primary source is inadequate.
Q. What are the top three things you look for when considering an “investment” partnership with an entrepreneur? Why are these three things the most important to you?
A. I am going to reword to say that when I am reviewing an opportunity to provide financing to an entrepreneur, the three things that I am most focused on are going to be the strength of management in regards to knowledge of their industry and ability to execute as borne out by historical success, the amount of equity that the entrepreneur is able to put into the venture, and the strength of the sources of repayment.
Q. How important is a formalized business plan for a venture when a bank is considering an “investment?”
A. I can’t overstate how important a formalized detailed business plan that included realistic forecasts would be in obtaining a serious audience with a financial institution.
Q. What are the three most important financial measures (statements, ratios, etc.)?
A. There has to be confidence that management can produce accurate and timely financial information, not only to the lender but also that they are paying attention to the business factors that will indicate that they are successfully executing on the business plan. It is not uncommon for a start-up venture to take some time to be profitable, therefore it is critical that you understand their sources of capital and how long their horizon is to reach profitability. Generally, even those ventures that turn out very successful take longer to get there than was estimated by the owner/entrepreneur.
Financial performance and attention to the statements is important, but it has to be combined with a boots-on-the-ground familiarity with management and the company.
Q. How does a bank, for example, use ratios to identify potential problem areas of a borrower’s performance when compared to an industry sector? Which ratios are most important and why?
A. The most common financial ratios that are watched in a traditional commercial bank environment are balance sheet leverage, cash flow or fixed charge coverage and cash flow leverage. Balance sheet leverage measures how much equity the company has versus how much debt they have (for every dollar the owner invests, how much does he borrow). Some industries will naturally have higher leverage than others if they are capital intensive and have to invest heavily in equipment or infrastructure to operate. Cash flow coverage, debt service coverage, and fixed charge coverage all are measurements of whether the operations of the company can generate adequate cash to satisfy all of the demands on that cash. Cash flow leverage is similar to balance sheet leverage but can be used as an indicator when you have a young or rapidly growing company that doesn’t have a lot of equity built up yet, but has demonstrated the ability to generate adequate cash flow to consistent meet their obligations.
Q. What advice would your offer an entrepreneur seeking start-up or early stage financing?
A. Be prepared with your business plan, knowledge of the industry, and distinctive competencies that you bring, and identify the risks and the steps that you are taking not only to mitigate those risks but also to mitigate the loss in the event the risks are realized.
Be realistic in your expectations and understand that you are seeking risky capital and it is likely going to be more expensive and more cumbersome than traditional bank lending.