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Newsletter: Lending with a Long Umbilical Cord

Nov 1, 2010 8:26:00 AM / by Tim McCarthy

In lending, particularly to the un-bankable, disciplined due diligence is a critical success factor.  Once loans are made, coaching and connecting regularly with the borrower assures their success and reduces your risk.  [more]

Lending money is generally a high risk business. That’s why there are so many complicated formulas and covenants now with each new deal. The quant jocks are on the loose and believe that risk problems are best solved by formulas and spread sheets.

And of course that’s not entirely true. Spread sheets and covenants are necessary, but they are only one piece of the puzzle.

The most important of the other pieces in my view is consistent discipline and follow through.

Right now, lending is pretty unavailable unless the loan you seek has little or no risk attached to it. It’s been this way for almost three years now, since lenders arrived on this side of the great recession. All people we’ve worked with in non-profit lending have been turned down by the banks. There is no “room at the inn” anymore for people who lack strong collateral. And yet with a dozen or so loans we’ve made to date, no one has yet missed a payment.

How have we done that?

The answer, which we learned from the first microfinance organization we worked with (WECO) is that we attach a long umbilical cord to every new loan we make.

Lessons learned from WECO and our own experience working with “unbankable businesses” indicate that there are five key disciplines, each of which reduces the loan’s risk.

  1. Know the character of the person you’re lending to. Most importantly, we try to measure if we think the borrower/entrepreneur is coachable.
  2. Lend only once a sound business plan is finished and approved by three or more smart business (not banking) people.
  3. To the degree possible, disburse loan money directly to the vendors – not to the borrower.
  4. Create key performance indicators in advance – numbers which measure success/failure. NOTE: Even more important than bank required covenants and targets are business targets. That way, we rarely will have to discuss covenants.
  5. Set frequent meetings (monthly) in person with the loan recipient/entrepreneur.

Each of these disciplines, put together, comprise the “umbilical cord” we attach to our “baby” entrepreneurs.

The most important ones are the first (coachability) and the last (frequent meetings), in my view.

Here’s why:

It’s hard to find a smart person with a good work ethic and a great concept.

It’s even harder to find those qualities in a person who doesn’t think they know it all.

Perhaps by definition a person willing to risk starting their own business has a big ego. It’s from a healthy ego that passion and persistence are derived.

But that same strong ego makes us hang onto bad practices too long, often times fooling ourselves into believing things that seem true for others but just aren’t true for us.

So our little lending group seeks people who are open to coaching, open to change. And it’s not because we hope they will do things our way. It’s so that when we see issues that are more easily seen by outsiders, they’ll work with us to solve them.

This leads me to key factor #5 which we call the “Woody Allen Rule.” If you’re my age or older, you may recall Allen’s famous line that “80% of life is showing up.”

And that’s what we do.

We put on a class every month for our borrowers. We show up. And we insist that they do the same.

I learned this from the peer group (Vistage) that I’ve been going to every month for 15 years now. That is, no matter how good my plan is, it’s bound to change. And no matter how smart I become, I will still make substantial errors along the way of implementing that plan.

At these meetings with our borrowers, we do very little “telling.” Instead we assign one topic for each meeting (key measures; marketing; pricing; planning for example) and then we insist each borrower show and discuss their own stuff.

I believe that lending will only loosen back up when banks and other lenders realize that the “destinations” they create with spread sheets and covenants are only the first step in the process.

The rest is a journey. It is a journey that requires patience and coaching and – just showing up.

Great businesses, the banks or the entrepreneurs, are rarely built with low risk/no risk loans. And so I hope we’ll soon see lenders re-entering (what I’ll call) the smart risk business.

If they don’t, someone else will. I plan that one of those will be The Business of Good.

Tags: Newsletter, Planning, Process, Coaching, Entrepreneur, Lending

Tim McCarthy

Written by Tim McCarthy

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