Question

Compare a new venture to an existing company and explain why existing companies can obtain bank funding and new ventures cannot. In replies to peers, review the criteria needed for financing and discuss how those needs differ based upon the business selected.

Answer 1

Existing companies pose relatively less risk for bank lenders as compared to new ventures. This is because existing companies have operations and cash flows which can be verified. They may also have sufficient assets to put up as collateral for the bank loan. New ventures may not have sufficient assets as collateral for the loan. Also, their cash flows are only projections/estimates, and the actual cash flows that materialize may be significantly different.

Thus, banks are not keen to lend to new ventures due to uncertainty of future cash flows, and insufficiency of assets

The criteria for bank financing is usually :

• Sufficient assets to put up as collateral for the loan
• A minimum of 3 to 5 years of operations with positive cash flows and profitability
• Lower proportion of fixed costs (compared to variable costs) in the cost structure

These needs differ based on the type of business :

• A services company may not have sufficient assets, but the predictability of its cash flows may be higher
• A business with a high operating leverage (a higher proportion of fixed costs) is more risky to a bank lender because of the high monthly obligations to pay. Even though it may have sufficient assets, it may be considered too risky for the lender
• A firm with a long operating history and profitability, but inconsistent cash flows may be considered too risky for the bank lender