Firms Can Score at the Bank With an ‘Airball’

Next time you see your banker about a business loan, ask him or her to tell you about:

* Pre-revenue loans;

* Pre-profit loans;

* Bridge loans;

* “Airballs.”

If you get a blank stare for an answer, you may want to find yourself another banker.

Why? Banks are flush with money these days, and as they campaign to put it to work, they find lending opportunities in the robust economy of Southern California and across the country that didn’t exist a few years ago. Indeed, they create new ways to lend money to small and middle-market businesses, along with new ways to assess and manage the risks of doing so.

For the owner of any such business, this is good news. Banks have money to lend, and new ways to lend it to companies doing both domestic and foreign business.

Take, for example, pre-revenue and pre-profit loans, bridge loans and airballs.

As you might surmise, pre-revenue and pre-profit loans go to start-up and early-stage companies showing neither revenue nor profit. Bridge loans go to companies gearing up for a round of equity financing or for a public stock offering. Last but not least, airballs go to companies with no collateral whatever.

If you also surmise that banks shied away from such loans in the past, you’re right. But it’s not true that all such loans come with huge risks, or that banks charge high interest rates when granting them.

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Instead, banks look to different sources for comfort. For example, they find ways to lend against inventory or receivables overseas, even when they can’t protect their interest with liens. Or they take some of their compensation in the form of warrants against stock in the companies to which they lend.

And where they don’t find five years of operating income and three years of profit--the criteria banks traditionally use to judge lending risk--they look for other signs of the borrower’s ability to repay a loan.

Specifically, they look for:

* Professional managers deeply knowledgeable about their industry;

* An outside board of directors equally steeped in the industry;

* Investors prepared to participate in an upcoming round of equity financing.

“There is a robust environment for start-ups and emerging companies,” says John Otterson, a senior vice president of Silicon Valley Bank, who specializes in lending to technology companies.

“And there’s a lot of capital available to these companies from banks, from non-bank lenders and from other sources such as venture capitalists and equity investors,” he said. “And because of the high liquidity in this marketplace, business borrowers can get highly competitive terms.”

Pre-revenue and pre-profit loans, for example, may come with interest at prime plus 1.5 points for a credit-worthy business, more for companies presenting a bigger risk, Otterson says.

Banks do not, of course, shower money on business borrowers willy-nilly, Otterson says. They still want their depositors’ money to come back with interest. They just look for security in new ways.

When making pre-revenue or pre-profit loans, for example, they may take liens against inventory or equipment, he says, or they may secure a loan with a senior claim against general corporate assets. But they find comfort in the track records of the company’s managers, directors and investors, Otterson says.

Specifically, bankers look to the track record of the management team in building high-growth companies, Otterson says. These days, good managers don’t work for one company for 35 years, he says. They follow exciting work from one growing company to another, building records that give bankers comfort that, having succeeded in the past, they will do so again.

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Put another way, bankers consider the skills of the management team as important as the hard assets that secure the loan, Otterson says.

“Good managers are skilled at building companies,” he says. “They may have never managed a company making the same product in the past, but they know how to make emerging companies fly.

“The same is true of boards of directors and equity sponsors,” he says. “We look for track records in fostering high-growth companies.”

In some respects, the new lending isn’t really new, Otterson says, but rather just more aggressive. For example, bankers have always lent against equipment, inventory and receivables--so long as the collateral remained within arm’s reach. Now they lend against such assets even when overseas by forming partnerships with foreign banks to oversee collections.

In other respects the lending is new. Not long ago bankers did not lend to companies without solid operating histories, with or without hard assets to secure a loan, Otterson says. Bankers still want security, but they define it in new ways that make it possible for them to lend even to companies showing no revenue or no profit.

They even shoot airballs, he says.

“An airball is that part of a loan not backed by collateral,” he says. “You make it to a company when you are highly confident that it will hit revenue projections or get venture funding.

“But neither is certain,” he says. “Such loans involve a much higher level of risk than typical bank loans, as there is no immediate source of repayment. It’s analogous to the basketball shot made from so far away that there’s a distinct possibility that it won’t hit the basket.”

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How to get financing will be a topic of The Times’ Small Business Strategies Conference Oct. 17-18 at the Los Angeles Convention Center. Columnist Juan Hovey will be featured. He can be reached at (805) 492-7909 or via e-mail at jhovey@gte.net.