Why banks love GTi's & hate excavators

Having rich parents will always be your best investment strategy, they can buy you as many GTi’s and excavators as you want and the best part is that you don’t have to pay them back.

You see, unlike banks, parents are in the business of funding dreams, they don’t have shareholders to account to and for so long as their source of income is not at risk why would they need you to repay them? Any monies advanced to you do not affect their ability to generate an income or return from their source of income.

People often lament the fact that banks are more willing to fund fancy German machines but not startup businesses or businesses generally. The starting point is understanding what a bank is and what its business is, here’s a bit of help: The Business of Banks

Now that we have that out of the way. When providing loans, banks assess risk, the risk is attached to the ability of the person or business being able to repay the loan - the whole loan plus interest. Providing finance for a German machine like a GTi poses a different risk to that of providing funding for a business and a very different risk profile to funding a start-up.

When financing a vehicle banks consider the following factors:

  • the credit standing of the customer;
  • the ability of the customer to repay the loan advanced from their income (affordability);
  • the value of the asset being funded; and
  • the recovery rate in the event of repossession.   

The biggest risk for a bank is therefore the ability of the customer to retain their job (perhaps a bit tricky in current environment) and continuing to make payments on each repayment date. Should the customer fail to make repayments the bank will repossess the financed asset and sell it for ‘market value’. Needless to say, the market for GTi’s is pretty liquid, meaning the bank will always stand a good chance of recovering its money: safe business for the most part. 

Funding a startup business on the other hand is a lot more trickier. Basically you are funding a dream that has the potential to be something good. That is not a great position for a bank as debt requires certainty. Banks rely heavily on the historical information of a business to determine what debt levels will be sustainable for the business. A startup business and many businesses that are barely surviving do not have this information, making it difficult for a bank to advance funding because there is no certainty in repayment. Add to that the fact that startups and most businesses do not have security to off the bank to rely on should the business fail, the proposition becomes even more difficult. 

If you add the global statistics of successful startups this becomes even more difficult: about 20% of businesses fail in the first year, 30% in the second year and more than 50% by the end of year 5. In South Africa between 70 - 80% of businesses fail within the first 2 years and only around 4% survive beyond year 5. Enter COVID-19 and the picture is even more bleak.

As you can see, the business of funding dreams is very risky with an uncertain return which is why it is more preferable to seek an equity partner opposed to approaching a bank for debt on a startup or relatively new business without a stable track record. An equity partner will share the risk in the business, they put in money in exchange for part ownership of the business to be able to share in the return of the business should the business become successful.

So if you want to buy excavators without a guaranteed contract using debt funding from a bank, you can see how difficult a proposition this is. There is no certainty in the business obtaining long term sustainable contracts, there is no historical information regarding maintenance, driver capability, business operations etc. Also the market for second hand excavators is not that great, so in the instance the business doesn’t work out the recovery rate from the sale of the asset will not be that great and this is why funding GTi’s will always make better for credit.

The reality is that banks can’t afford their business model to be dependent on the risk and volatility of a startup up business. The best equity partner will always be your parent. Parents are like little fairy’s and are there to support their children in each and every endeavor and are likely to provide you funding with very soft terms and not expect a return. The richer they are the softer the terms. Jeff Bezos' parents ploughed $245k into his e-commerce startup. Donald Trump received "a small loan" of $1m from his father. Bill Gates' parents funded his founding company. Kylie Jenner had an already famous family.

Unfortunately most of us will never have the luxury of tooth fairy parent’s funding our dreams and will look to financial institutions and early investors to fund our projects. Whether it’s debt or equity being provided - it never comes cheap. Always weigh up the costs of sacrificing ownership early on vs. the pressure of having a young business weighted down by a large loan. 

Slow and steady might win the race, but at 40 km/hr an excavator could actually be a bit too slow. 

*Disclaimer: The contents of this article should not be considered as legal, professional, financial or any other form of advice. These are merely views based on the writer’s personal experience. Readers should obtain independent advice on any matter prior to making any decision.

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