A short article on small business financing caught my attention today. A study conducted in Spain, you can find ithere, attempted to test the hypothesis that small business with a lower risk profile will self-select financing options that trade collateral for a lower interest rate while business with a higher default risk will self-select for financing options that have a high interest rate but no collateral. The study is very interesting, and although definitely on the academic side, it poses serious questions for young entrepreneurs.
1. If I believe my idea is sound and profitable (almost everyone does) do I raise the necessary collateral to have access to a lower interest in a loan?
2. Instead of using the collateral in the loan should I invest the money in my company?
3. If I have no collateral, is my business ever going to receive funding?
Financing for small business is a touchy subject. The link between collateral and riskiness of the business can be argued both way. The bank might be trying to diminish its risk by asking for a higher collateral. On the other hand the higher collateral might be the result of conditions within the bank itself or macro-economic conditions outside of the control of the small business. My advice to small business owners is to carefully evaluate the need for financing to begin with. Everyone will push financing, from small banks to venture capitalists, but they have their own interests. The bank needs a client, the venture capitalist wants a piece of your company if successful. If you don’t have a plan as to what you are going to do with that money, detailed plan, then seriously reconsidered asking for it to begin with. Slow, steady, internally financed growth expansion might be a better option.