The hunt for capital
Home equity loans fraught with peril
June 18, 2005
The most expedient way for entrepreneurs in Routt County to capitalize a new business simply might be to apply for a home equity loan. But there are risks inherent to that strategy, and not all of them are obvious.
“There are some real train wrecks here,” Mike Forney said. “Some people take out home equity loans before they complete a business plan. By the time we get to them, they’ve spent that money.”
Forney is a volunteer counselor with the Yampa Valley office of SCORE, a nonprofit organization that counsels potential and existing entrepreneurs on basic business survival skills. His business background includes many years in mortgage lending on the East Coast.
Forney said the ease with which startup ventures can acquire capital through home equity loans can lull entrepreneurs into a false sense of complacency, actually undermining their businesses.
Forney made his comments during a Tuesday roundtable with local bankers. It was planned to explore how advocates for small business in the valley can better prepare clients to approach financial institutions for loans.
Scott Ford of the Small Business Development Center at Colorado Mountain College and Steamboat Springs Chamber Resort Association Business Resource Director Noreen Moore were there with other SCORE volunteers. What they heard from the bankers is that although they work with startup businesses, they are seeing fewer applications for $10,000 to $50,000 business loans.
Moore said the notion of people financing start-up businesses by borrowing from extended family members is nothing new.
“Many start-ups in the old days, using the three F’s (Friends, Family and Fools), would jump in heedless of the perils,” Moore said. “It’s correct that people here have increasing equity in their homes to tap into. I think the one thing that comes to me, from my viewpoint of community impact, is the social angst that occurs when we see failed businesses. The community is mindful that one of its young has been injured, and depending upon where the decimal point lands, it can be serious.”
In some cases, Moore added, failed business owners leave town, and that harms the business owner and the business community’s self-image.
Ford said the ability to quickly leverage as much as several hundred thousands of dollars in home equity provides a false sense that everything is OK.
When things go wrong, the obvious risk is of losing one’s home. But less apparent is that an easy home equity loan allows fledgling entrepreneurs to bypass much of the work start-ups must complete to even approach a bank for a loan.
Bankers want to see a business plan, Ford said. It doesn’t have to be a sophisticated financial document, but it has to articulate exactly what product or service the owner intends to provide, and what the local market is for those goods and services. Lenders also like to see some indication that a market study has been done to confirm that the business can generate sufficient cash flow to justify its existence and pay off a loan.
SCORE can help entrepreneurs determine whether their business plan is feasible, and the volunteer counselors won’t hesitate to utter the words, “This ain’t gonna work,” Ford said.
Before they make an appointment with a banker, SCORE clients learn to get their financial statements in order and understand them.
Cheryl Antalek of Vectra Bank said some of the young businesses she works with overlook cash-flow projections.
She cited the case of a local business that opened to immediate success, but hadn’t really made plans for how much money it would need to access in the near term.
“They really hadn’t looked at sales for June, July and August,” Antalek said. As a result, “they didn’t know how much of a credit line they would need.”
Bankers at the meeting agreed that the more SCORE counselors, as a neutral third party, can help entrepreneurs look objectively at their businesses, the easier it will become for the bankers to work with them.
Bill Leeson, who is semi-retiring from his post as regional president for First National Bank of the Rockies, said the single most difficult thing about approving a loan for start-ups is that they don’t have a track record of cash flow statements to back up their request. Even if there’s strong collateral in place, bankers want to see evidence of cash flow, Leeson said.
“Whether it’s a $10,000 loan or a $500,000 loan, it takes the same amount of time for the banker,” Leeson said. “To invest a lot of time for a small amount of money is difficult.”
Leeson said bankers he formerly worked with in Illinois found a solution to funding small business loans. Each bank contributed a modest sum to a loan pool and turned over administration of the loans to a community organization that was empowered to make the decisions.
P.J. Wharton of First National Bank of Steamboat Springs welcomed the news that SCORE volunteers are willing to guide start-ups through the detailed process of applying for loans from the Small Business Administration. He agreed with Leeson that it’s difficult for bankers to spend a great deal of time helping never-ever entrepreneurs apply for small loans.
“We can’t spend eight hours with these guys on a $25,000 loan,” Wharton confirmed.
Ford said area advocates for en—-trepreneurs want to help them be——come more sophisticated in their search for capital.
“We’re in a partnership to build smarter and stronger entrepreneurs,” Ford said. Start-up business operators in this community “have an entrepreneurial mettle that almost makes them look like homesteaders. Hopefully by the time you see an individual, they’re much better prepared and they’re not looking to you to validate their idea.”
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