Ethical Obligation of Lenders

Scenario:


A struggling small business hires a consultant a few years ago (prior to the recession). The business would like to secure some additional funds to finance its struggling operations. The analyst, after reviewing the financial statements of the business, informs the owners that financing will be difficult to secure given the current state of the business, namely negative owner's equity, and sets to work with the company to begin to write a business plan to move the company through the existing troubles and position it to be able to acquire the financing that it needs.

Just prior to this the owner had moved his bank accounts to a different bank in order to refinance some existing high interest credit card debt into a long-term loan with a better interest rate. Concurrently to writing the business plan, the owner continues to talk with his new bank, and they offer the owner an unsecured line of credit without requiring any financial statements from the company. Rejoicing with the company owners at their happiness, the bank does not take the time to explain to the owner what the bank expects to see as far as managing a line of credit.

The consultant is not only flabbergasted, but has also now had her credibility undermined since the very thing she said would be impossible happened.

Continue the story:

Work on the business plan stopped. The business continues operating in much the same manner as before, drawing on the line of credit to finance the company’s short-falls, but never paying the line back down. The consultant repeatedly warns the owners that the bank will want to see the line of credit used and then paid down, but why should the owners listen to the consultant when she was so wrong the first time? Then the recession hit. The business took a hit and proceeded to draw even more on the line until it reached its credit limit. Given the pressures to the banking industry, the bank reviews the line, NOW asks to see the financial statements, visits the company, and determines that the line is operating as a long-term loan and thus they are pulling the line and refinancing it as a long-term loan which, by the way, they would now like secured by the owner’s home and the interest rate has doubled. All perfectly within the bank's rights.

Question:

Does the bank have an ethical obligation to clearly explain the different financing options to a small business owner? Should the banker assume that the owner is knowledgeable about the difference between a loan and a line of credit, for example? Should they be required to clearly explain that they have every right to reevaluate the line of credit at any time and call it or change the terms? My pharmacist asks and explains to me how my medication works…banks are also dealing with lives, the lives and fortunes of small business owners. What’s your opinion?

Improved Oversight Needed for New Businesses

Calling all you bankers, lawyers, accountants and other service providers who help people start their new businesses, please help us out.


We are finding far too many small businesses that have really created a mess in their first year or two of business because they didn’t understand some of the requirements of the particular business entity that they chose and other aspects of running a business. I am talking about payroll issues and accounting problems primarily.

A Sub-S corporation has different tax and payroll issues than a single member LLC and if an entrepreneur operates all year on their own and only meets with an accountant or tax preparer during tax season, there may be numerous problems with serious consequences including large penalties, fines, and interest which simply don’t need to occur. Many owners don’t understand all the rules surrounding employees and payroll and run into problems with withholdings and taxes and paperwork. Sure, it is ultimately their responsibility to know the rules, but I think we sometimes assume that the new business owner is more tuned in to the financial part of their business than many actually are. So much money and heartache could be saved if we perhaps worked a little harder to make sure that a new business owner has a plan for meeting the required tasks and that we follow up diligently during their first year in business to make sure that they are doing things correctly.

We would love to see some way of catching a business owner as the company is being established and providing a checklist to make sure they are starting strong and correct. It would be great if a personal banker helping a new business open a checking account asked the owner if they had all their employee and accounting issues properly handled. The same holds for attorneys helping set up LLCs and other business entities. So how can we all work together to give these small businesses a fighting chance to succeed?

Your thoughts? Comments?

Recommended Reading for Entrepreneurs

As a change of pace, we are listing some of our favorite on-line magazines, blogs, and websites that contain useful content for small business owners. We also recommend the Wall Street Journal, your local newspaper, and a trade magazine for your industry so that you can stay on top of emerging trends.

1. Entrepreneur Magazine  http://www.entrepreneur.com/
2. Entrepremeur for Women Magazine http://www.womenentrepreneur.com/
3. Inc. Magazine http://www.inc.com/
4. Business Week for Small Business Magazine www.businessweek.com/small-business
5. My Venture Pad Blog http://www.myventurepad.com/
6. The Customer Collective Blog http://www.thecustomercollective.com/
7. IRS for Small Business www.irs.gov/businesses/small/index.html
8. SBA http://www.sba.gov/
9. CPA Letter Daily  cpa@smartbrief.com
10. The Business and Financial section of the New York Times http://www.nytimes.com/pages/business/index.html


Do you have any you would like to add and share?