Those who have experience in startups know that a large part of this fee is not allocated to what banks usually consider to be “high-risk” companies and that, in turn, startups are not usually attracted to their funding because the vast majority of the time banks require personal guarantees. But in recent years things have started to change and the relationship between the two has begun to take a different form...
The main Spanish banks, such as BBVA (Spark), Sabadell (BStartup) and Caixabank (Dayone), have created a network of offices specializing in startups and now offer products and services for them, including, among others, traditional products (payroll accounts, cards, insurance, etc.), growth loans and in some cases even venture debt. These banks are leading the way in which the industry perceives startups, since they understand that these types of companies must have different development and funding models. For this reason, they have developed a specific risk circuit and have formed teams of analysts dedicated to working with emerging companies.
What does a bank analyze when it comes to financing a startup?
A bank's top priority when it finances a company is to get its money back (plus interest, of course). To analyze the probability of this happening, they will first look at qualitative aspects about the entrepreneur and then the income statement, the balance sheet and the cash flow statement, since together they help the bank to analyze the financial strength of a company. They also provide a quick picture of financial health and their underlying value. There is a methodology that is taught to all bank employees from their earliest days in any bank, which is called “The 5 Cs of Credit” and which covers (in English): Character, Capacity, Capital, Collateral and Conditions.
- Character: An experienced banker begins his analysis by what in English is called the “Character” of the customer. This includes first of all the entrepreneur's reputation in the market. Are they serious and responsible people? Have you always paid your debts? Have you been involved in any complex matter with public repercussions? Here it is a matter of looking for and finding concrete elements that establish a pattern of seriousness and responsibility versus another pattern of recklessness and foolishness. After all, this evaluation boils down to the loan officer's impression of you and your company. The best way to pass a subjective character test is, in addition to having an immaculate market history (not having unpaid debts with the Treasury or other banks, or suppliers, unfulfilled business obligations registered with Asnef, suspended or closed bank accounts in the financial system, bankruptcy records, etc.) to do your job very well beforehand. For example, when the banker requests a list of documents, he needs all the documents listed, not a partial list. Get the information they need, organized and ready to use. Show the banker that you are an organized, reliable and proactive person.
- Capacity: Then, once the “Character” test has been passed, it is followed by the analysis of financial parameters, starting with the “Capacity” test, which measures the ability of companies to repay their debts, or in other words, their capacity to generate cash. In the case of startups, it is well known that this part is the most complicated because their focus is precisely on growth and for this purpose they will use all their cash plus everything they can get from external funding. Therefore, experienced startup banking analysts will look instead at revenue. Revenues and their growth rate can serve as an indicator of potential future benefits, and therefore cash flows, and ultimately whether they will be able to pay the bank. Newly created startups with zero or low revenue figures will continue to have serious difficulties obtaining financing from a bank without requiring personal guarantees.
- Capital: Capital or also called own funds constitute the assets provided by the owners (in a startup entrepreneurs and private investors), it is also a critically important metric for banks since it helps them determine the commitment of the owners, the general financial health and the stability of your company. If you have a positive net worth, it means you can cover your liabilities, while a negative net worth can be a warning sign of a lack of commitment, weak financial health, and possible imminent bankruptcy. It's no secret that banks are wary of granting loans to those with low net worth, let alone a negative one, since it has always been a barrier to entry to bank funding for new companies.
- Collateral: This is where entrepreneurs and startups enter swampy terrain in the face of banks. In the case of large companies, which often have significant assets under their ownership (factories that mix real estate, capital goods, and non-perishable stocks; assets such as trucks, ships, planes, receivables, etc.) it is relatively easy to find assets to be granted as mortgages, pledges, factoring, etc. The banker will identify the asset that best links the current transaction. But in the case of startups, usually the only asset is the personal guarantee that the entrepreneur can provide. At Intelectium, we always appeal to the prudence of entrepreneurs and recommend that they NEVER offer personal guarantees. Launching a startup involves enough efforts and sacrifices of all kinds to add to them being homeless, or with an enormous debt to pay after having to file for bankruptcy followed by a liquidation of the company.
- Conditions: Another key factor in the 5 Cs of credit is the general environment in which the company operates. The banker evaluates the conditions surrounding your startup and its industry. Determine the main risks you face and whether these risks are sufficiently mitigated. Even if the company's historical financial performance has been good, the bank obviously wants to be sure of future viability, and will not provide a loan if the startup is threatened by an unmitigated risk that isn't being addressed sufficiently. In this evaluation, the banker will observe things such as the company's competitive landscape, the nature of its relationships with customers, potential supply risks, possible macroeconomic or political factors that affect or may affect the company, etc.
Regardless of the factors listed in the context of the 5 Cs methodology, the bank will also evaluate:
- The box: This is where banks can see the actual level of access a company has to cash and hard currency. The data is obviously very important because it is what allows a company to carry out its routine activities. For example, let's say that a company has a cash register of 20K€ and they see that in P&L it is losing 5K€ per month... it means that in 4 months the company can break cash and go into liquidation.
- The debt: If a company already has large amounts of debt, then it will be more difficult to assume more if the profits are minimal or no.
- Business plan: The pace or growth potential of the startup is also an important criterion for banks. Along with your financial statements, they will evaluate your business team, the product/service, the target market and the company's general objective to get an idea of the future of your startup. In this regard, special emphasis must be placed on the importance of the experience of the entrepreneurial team in the sector, the training and the profiles that make it up because, leaving the numbers aside, it shows the banks that the project has the capacity to be carried out/executed with solvency. All of this information must be included in the business plan, and so you have to make sure that you are prepared to the highest standards.
- Other financial documents: The bank may also require other financial records, such as the company's previous bank statements, unpaid invoices, and accounts receivable. Depending on the lender, these records must go back to a certain period of time.
When is it recommended to access bank finance?
It is likely that in the first instance the bank will ask for a guarantee, since no company, especially start-up companies, is free from the risk of bankruptcy. The guarantee gives protection to banks, so they usually require a series of payment guarantees, usually in the form of real estate or a guarantor. It's important for entrepreneurs to understand how these guarantees work, since their personal future may be at stake when opting for this type of funding. As we have already said above, Intelectium recommends that an entrepreneur NEVER take on a debt that involves providing personal guarantees or a guarantee from family or friends. For this reason, it is preferable in the first instance to resort to public funding such as Enisa at the national level or ICF (Catalonia), IVF (Valencia) or any other national or regional government institution.
Another important issue in the framework of bank financing is that when things go wrong, bankers — due to the internal processes of most banks — must pass the problem on to the legal department, which generally has very defined policies aimed at recovering loans in whatever way they consider most appropriate. This means that if friendly negotiation fails, they will go to court, which may precipitate the company's need to request protection through the filing of a pre-bankruptcy and directly bankruptcy. This is practically a death sentence for the company since there are very few that can recover after reaching this situation.
For all these reasons, the time to require bank funding is when there is already a clear product-market fit in the startup and it is fundamentally a matter of covering the startup's working capital needs, rather than its structural funding.
Other articles that can help you:
