Capital is the lifeblood of any business.
But fresh infusions of money are particularly important for startup and small businesses, since they often can't fund new equipment, employees or facilities out of their cash reserves or profits.
The top three sources of new capital for small business are owner's equity (33 percent) bank loans (20 percent) and trade credit (15 percent).
Let's focus on bank loans and simple ways that small-business owners can improve their chances of getting a loan with the best possible terms through a fairly oldfashioned concept: building strong relationships with the right bankers.
With consolidation and technological advances in the banking industry, many businesses mistakenly assume that the era of relationship lending is past, that banks are all about hard, impersonal data. However, studies show that there continue to be real advantages to good lending relationships.
Businesses can enhance loan acceptance through establishing a relationship with the lender. The longer the bank relationship is, the greater the potential of obtaining a loan. A lending relationship also can result in lower loan interest rates, reduced collateral requirements, lower dependence on more expensive forms of debt such as trade debt, and protection against changes in the interest-rate cycle.
Of course, relationships enhance hard data; they don't replace it. As technology has improved, more lenders evaluate loans using information such as financial statements, assets or credit scoring. Audited financial statements provide greater confidence in the numbers, and many banks-especially large banks-rely solely on the collection of hard facts to accept and price loans.
However, many community-oriented banks supplement the data with information based on previous relationships.
The importance of relationship lending differs for small and large businesses.
Banks making large business loans (frequently referred to as transactional loans) demand more hard data to assess the loan size and rate. In most cases, the financial data is easily comparable-a large company's financial health can be benchmarked against corporations of similar size.
But small businesses are more difficult to evaluate using just the numbers, so an existing relationship can help establish confidence in the company and lead to a successful loan.
How can you establish the relationship with your bank? Intensity and duration are both components of a close lending relationship. Intensity covers the range of services that the customer has with the bank. For example, the status of depository accounts provides lenders with useful information beyond what's found on the loan application and financial statements.
The duration of the relationship with a particular loan officer also can be important, since loan officers have access to the greatest amount of soft information about a small business. They also may have external information, such as the company's method of interacting with suppliers, customers and the local community.
Small-business owners should weigh these factors when choosing a bank:
Does your bank value soft data, or is the loan process strictly transactional?
In anticipation of possible lending needs down the road, are you willing to put your depository accounts at a bank that values relationship lending?
What is your bank's position with regard to mergers or acquisitions?
Since small-business owners often don't have the financial leverage or broad resources of their larger counterparts, they need to build strong relationships in every facet of their business, including with their banker.
Viewing your bank as an important stakeholder and establishing a good ongoing relationship can pay off, in lower interest rates and greater access to funds. That can translate into faster growth, benefiting both the small business and its banking partner.
Carow is an associate professor of finance at the IU Kelley School of Business Indianapolis, where he also serves as chairman of the undergraduate program.