Frontpage News 2013 The banks support ...

The banks support growth in society

20 November 2013

Comment by Louise C. Mogensen, Deputy Chief Executive at the Danish Bankers Association

This week, it is the Danish Growth- and Entrepreneur Week (Week 47). The campaign aims to inspire as many as possible to launch their own companies and make established businesses grow. Banks are often accused that they will not fund entrepreneurs and thus do not support the growth of society. It is a misconception that could be related to the fact that the concepts of risk capital and debt financing are often confused. I treat them separately.

Risk capital - or venture capital - the capital invested when either individuals or professional investors buy shares in new companies. The capital is among other things used to develop new products and/or launch them. Banks should generally not buy shares in a company, unless what they invested in is in natural extension of banking or there are special circumstances that apply. This is according to the Financial Business Act.
Banks may play another important role. A company can get loan financing in the bank if the company can demonstrate that it can run a healthy business, including making money and if it can provide collateral. The bank must have a reasonable assurance that the money will come back again. Let me illustrate with a calculation. A bank lends out 100 DKK at an interest rate of 10 percent. It provides an annual income of 10 DKK. If a company goes bankrupt, the bank may lose those 100 DKK, if collateral for the loan is not provided. This means that 10 other similar customers are to pay their payments and fees before the loss is recouped again. And I have not even taken into account the bank's fixed costs or returns to shareholders.
Unfortunately, it is far more than every 11 company that goes bankrupt among start-ups. According to the Danish Business Authority’s Entrepreneurship Index from 2012, 19,333 new businesses started in 2004. Barely half existed after five years.
Therefore, the banks are in a situation where they not only through higher prices can cover the relatively high risk by financing entrepreneurs. As I mentioned, banks may not, even as investors, take part in a potential gain (upside) for the entrepreneur if it goes well. Banks can only cover any losses from the interest rate that the remaining customers pay. Therefore, it is difficult for an entrepreneur to get debt financing for the development of a new technology or product, or if the business is a start-up and has limited collateral and no history. However, the probability of getting loan financing in the bank increases considerably if the entrepreneur can obtain venture capital, for example from an investor.
But where should the entrepreneur seek venture capital? The entrepreneur can actively seek out investors and be willing to pay the "price" in terms of influence, that is, accept co-owners. However, the entrepreneur should push himself and provide equity financing. It is always easier to let go of the idea, if you do not have any money at stake. And why should others be interested in taking a risk if the entrepreneur is not? The entrepreneur as an owner gets part of the potential upside, but also part of a possible downside. It makes the entrepreneur make more rational decisions and not take on excessive risks.
I would also urge that the entrepreneur makes use of all the consultants and specialists he or she has access to. Find an auditor, go to Væksthuset and seek advice from the bank. Banks are used to assess budgets, financial reports, ask the right questions, and they have a network they can activate, which can help with inspiration, knowledge and possible partnerships for the entrepreneur.
The bank is interested in giving the entrepreneur a successful start. When the company starts making money, the bank can assist with an overdraft facility. If the company over time demonstrates sustained stable earnings and cash flow, there is fertile ground for expanding its facilities with the bank, for example with loan financing.
Thus, there is no contradiction between banks and entrepreneurs. However, there is a need for clarity about the role banks can and are allowed to play in the financing of new companies.
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