Startup loans: how banks can generate more profit
By Katerina Mansour - 14 February 2022
Working with startups is still largely seen as a high-risk decision for banks. Startups often have uncertain business models and might take years to reach profitability. Yet, startups often rely on high levels of capital to develop innovative products. When weighing their options, bank loans often stand out as an ideal option. They provide entrepreneurs with the ability to secure necessary funds while retaining control over their company. However, because of the high risk of failure and/or bankruptcy, banks often face a struggle in trying to generate profits from startup loans.
Thankfully, over time, many solutions have emerged to help banks evaluate said risk. By using tools and services available to assess startups, banks can better ensure they generate profits from the startup they select as clients. Furthermore, banks have started to create new services that will help mitigate the risks startups present. These services typically entail accompanying startups in their development to increase their chances of success.
The importance of these new tools and services cannot be understated as, despite their high risk, startups also present high rewards. The number of unicorns that have emerged worldwide (over 900) is a testament to the immense potential that lies in the startup ecosystem. If banks position themselves as supporters early on in a startup’s lifecycle, they can reap significant rewards from the success that could ensue.
In this article, we’ll present an overview of some solutions and strategies banks can opt for in order to improve their profits when it comes to startup funding.
Beyond funding: advisory services
Besides funding, startups can significantly benefit from outside expertise to help them in the early stages of business. This advisory offering could cover a wide array of topics, such as:
- funding strategy,
- WCR management, etc.
As such, banks can either complement their startup loans with advisory services or create standalone advisory products. Banks will typically have a network of VCs, fellow entrepreneurs and other advisors they can leverage for these services.
Funding with more benefits: new types of startup loans
Banks can improve the outcomes of their relationships with startups by offering loans that are better suited to their needs. Startups come in all shapes and sizes, with highly varying maturity levels and needs. In recognition of this, many banks have been developing new services for startups.
For example, Raisesherpas and Crédit Agricole Île-de-France launched an “expansion loan” via a participative fund. This loan aims to provide entrepreneurs with a fast and non-dilutive way of meeting their funding needs. The loan does not require any deposit or guarantee. Raisesherpas has also chosen to work with Early Metrics to select its final candidates in a matter of weeks rather than months.
Another increasingly popular offer is venture debt. While the US may be ahead in terms of developing this funding vehicle, Europe is slowly catching up. For the startups who already have venture capital backing, venture debt from banks is a complementary source of funding. How much is leant through a venture debt loan and the clauses of such loan depend on the startup’s past funding rounds and other specificities, like its valuation. By definition, venture debt helps mitigate risk for bankers. Indeed, it involves providing non-dilutive funding to businesses that have already been approved and backed by a VC.
Measuring the risk: startup ratings & analyses
Banks can turn to startup ratings and analyses to help assess a startup’s credit risk. As the saying goes, knowledge is power. In this case, knowledge of a startup’s financials alone won’t be enough to fully assess its risk profile.
Banks need to take a more holistic approach towards a startup to grasp what its potential will be over time. The limitations of reviewing only the financials are increasingly understood in today’s ecosystem. Banks are moving towards more comprehensive strategies to assess a startup’s risks and determine whether they move forward with them.
Thanks to these types of assessments, banks can feel more comfortable positioning themselves as key partners to high-potential startups. They can build a strong relationship with the entrepreneurs in the early days, when it’s easier to directly reach out to the founders and create durable ties with them.
Launching soon: ScaleX, the next-gen platform for bankers
As mentioned above, optimising processes for risk and growth potential assessments is crucial to increase a bank’s profit through startup clients. But such processes can be long and complex.
That’s why Early Metrics has created ScaleX, a platform that helps bankers to quickly analyse a startup’s growth potential and its ESG maturity. Indeed, strong ESG measures are becoming imperative for businesses of all sizes. As such, Early Metrics offers ESG ratings. These ratings provide banks with the ability to assess to what extent their potential startup clients espouse ESG values.
ScaleX enables users to benchmark a startup against Early Metrics’ database of over 3,800 rated startups. Banks can get an overview of the SME’s value proposition, business model, strengths, weaknesses and financial data. Perhaps most importantly, bankers receive predictive signals to evaluate a startup’s growth and offer services accordingly.
Banks can use ScaleX to manage their portfolio more seamlessly. They’ll be able to analyse the marketing mix of their portfolio (maturity, sector, geography), see a clear ranking of the most promising companies in their portfolio, and easily track evolutions over time.
Despite the risks, startups undeniably present an immense opportunity for banks. Getting involved in the early stages of a startup’s trajectory and becoming a key partner will be highly beneficial in the event said startup encounters success. To mitigate risks and increase revenue, banks are now embracing some of the tools and strategies detailed above. It’s likely that new services and solutions will continue to emerge, as banks become a privileged partner for startups worldwide.