There are a variety of senior lenders in the marketplace. This group typically has a first, or senior, position in the collateral pool of a company. Commercial banks, the primary players in this group, are the focus of this chapter. Owner-managers are motivated to seek bank lending for several reasons. Banks historically have been the largest source of capital for small to medium-size businesses. Banks also typically have been the cheapest source of borrowed funds. Over the past 15 years, banks have broadened their offerings to include a spectrum of financial alternatives appealing to owners in need of more sophisticated services. Banks now serve as financial intermediaries. They lend, arrange, advise, and directly invest capital in private companies.
Bank credit is rationed based on the return needs of the institution. Banks seek to maximize the spread between deposits received and income-producing assets. Business lending is an example of the latter. Banks lend to small businesses only when it is likely that the loans will be repaid. Credit quality is enhanced by sophisticated underwriting techniques, such as credit scoring for individual loans and repayment projections for commercial loans. Even with these methods, lending to small businesses remains risky. This fact in part explains banks’ hierarchical decision-making structures. Most banks require a handful of bank officer signatures on the loan request as an experiential hedge against this risk.