Often entrepreneurs can forecast the cash flow of their company and anticipate future periods when they will require money to pay for supplies or build up inventory. Instead of borrowing the cash now and paying unnecessary interest, they can apply to a bank for a line of credit an assurance by the bank that, as long as the company remains financially healthy, the bank will lend the company a specific amount of capital. This does not guarantee that the bank will lend the money, rather it ensures that when the business wants to draw against its line of credit, the bank will review the company's current financial statements to verify that it still qualifies for the loan. Under certain circumstances, a business can obtain a guaranteed line of credit that promises the company that the bank will lend it money regardless of its current financial position. As you can well imagine, banks charge extra for the guarantee, typically 1 percent a year on the unused portion of the line of credit. Moreover, a bank will frequently require that entrepreneurs maintain a compensating balance, holding a specific amount of money in their checking account without interest.
Banks will frequently require collateral from the entrepreneur in order to reduce the risk of making a loan. Collateral may be in the form of any asset that has measurable value, including equipment, property, or inventory. If the entrepreneur defaults on the repayment of the loan, the collateral becomes the possession of the bank, which may sell the assets in order to recoup its losses from the loan. With a small business, banks often require that the entrepreneur and his or her key managers personally sign for the loan, offering their personal possessions as collateral. Obviously, this puts the entrepreneur at great risk. However, the rationale of the banker dictates that if you're not willing to put up personal collateral for the loan, then the deal is too risky for the bank, and the bank will deny the credit altogether.
Though commercial banks and venture capitalists differ along almost every dimension, the one thing that's important to both is your business plan. Having a well-articulated, accurate business plan with solid numbers that predict positive financial performance will be important to obtaining a line of credit from a bank. However, unlike the venture capitalist, the banker does not search for outrageous growth rates and a high potential return on investment. In fact, the banker could probably care less how rapidly your company grows. He's interested in ensuring that your company will continue to remain healthy, producing financial results that will allow you to repay the loan according to the terms of the agreement. You must be able to validate your financial projections and explain your assumptions in a manner that convinces the banker that you run a sound business.