Startups Need Cash Flow or Collateral for Bank Loans

Many fledgling companies find themselves in a Catch-22 funding crunch.

They don’t have the customers or contracts to get venture capital funding. And they don’t have cash flow or collateral to secure a bank loan.

Once things are rolling right along and the company isn’t as desperate for funding, it’s much easier to get a loan. But when they need it most, it can be difficult to find the money.

“We’ve loaned money to some of the Genesis companies because they had demonstrated cash flow or a bona fide contract to sell a product to somebody,” John Lewis, president of the Bank of Fayetteville, said, referring to the University of Arkansas’ Genesis Technology Incubator.

Otherwise, Lewis said, loaning money to a company that is “still perfecting intellectual property” is a big risk.

A Genesis company invented a frictionless brake and clutch for automobiles, Lewis said. Without cash flow or a contract to sell the product, the company couldn’t get a bank loan, and the invention was never developed commercially. That’s an example of when a venture capital fund could have helped, he said.

But Arkansas companies have so far had little venture capital help. At this point, Diamond State Ventures of Little Rock is the state’s only venture capital fund.

Lewis said the Bank of Fayetteville is helping form The Alpha Fund, which will serve as a venture capital fund to assist “embryonic companies.” So far, they have raised $850,000 and are shooting for $1.25 million. The fund raising will resume after the war with Iraq, Lewis said.

The Glass-Steagal Banking Act of 1933 prohibited banks from getting into the equity business. That opened the door for venture capital funds, which basically buy into a company’s business when they help finance it.

But for many startup companies, venture capital may not be an option, especially if the fledgling company doesn’t have contracts and customers.

“Venture capital is totally different from a bank loaning money,” said Dick McLelland, president of the Bank of Rogers. “There are people always looking for venture capital. There are some sources, but not many … Mostly, venture capital goes into bigger projects where people don’t have the capacity to get the loan themselves. Banks are reluctant to loan on that type of situation, without capital backing.”

The owners of those startup companies can still get business loans from banks, but that means paying interest on the loan. And they either need to have proof of cash flow (purchase orders or a good day job) and/or collateral (which may include personal real estate).

“Hopefully, they’ve got some kind of capital,” said Bob King, senior vice president of the Bank of Fayetteville. Startup companies should also have a budget or business plan and a good idea.

“I love ideas,” Lewis said. “I’m an idea man. But you’ve got to have more than ideas.”

If an existing business is seeking a loan, King said, they need to bring the following documents with them when they visit their local banker:

• The last three years of income tax returns (including depreciation schedules).

• Their latest interim financials.

• Any available budgets or projections for the business.

• An accounts receivable list.

• An inventory list.

• A list of major principals and shareholders reflecting their percentage of ownership.

• A personal financial statement from anyone who owns at least 20 percent of the company (or their guarantors)

• Product and service brochures, lists and catalogs.