What Your Banker Needs To Know

By Bonnie M. Brown, James F. Nielsen and Rowan M. Traylor

A study compares what you value most in a banking relationship—with what bankers think you value.

In late march, President Clinton announced changes in banking regulations which will allow banks to make more “character loans” to small business owners, loans that are based primarily on the borrower's reputation rather than his ability to satisfy rigid lending rules. This is timely news for thousands of family businesses.

Since late 1988 bankers have been reluctant to issue character loans, for fear of reprisal by regulators. As a result of this credit crunch, relationships between banks and family businesses have become strained. Business owners have had to jump through more hoops to get financing. Others have simply been turned down, many for the first time in decades.

The new rules don't signal easy credit, however. Bankers will still have to prove their lending decisions are sound. That means they will want to know more about ownership and succession issues at family businesses. Owners will have to be willing to explain their plans. Also, family businesses run the risk of losing credit during a leadership transition if bankers are not worked into the loop.

At the same time, bankers must realize that they may begin to lose clients; numerous family businesses were begun in the years following World War II, and many of the owners are now approaching retirement. Bankers face a potential backlash as increasing numbers of successions take place; the younger generation may not feel the same loyalty as their parents did, unless they have had the opportunity to work successfully with officers at the bank.

To avoid these potential problems, bankers and owners must have a clear understanding of each others' priorities and assumptions. This is particularly important for small businesses. Often, the local bank is the small business owner's only source of capital. Furthermore, small family businesses are among the strongest contenders for character loans; they are the very businesses that have long, successful track records but few financial resources to satisfy standard loan-approval formulas.

To find out whether bankers and owners understand each other, we conducted a study last year. Our objective was to compare the factors that family business owners deem important when choosing a bank with the factors that bankers believe owners deem important. If we were to find appreciable differences in expectations and bring them to light, both parties would then have a better chance to bridge a potentially damaging communication gap.

We asked family business owners to rank the three most important criteria for choosing a bank, from a list of 15 factors. We asked commercial bankers to pick the three factors they expected owners to choose as first, second, and third. We received responses from 92 owners of companies that varied in industry, location, and size (most had accumulated assets of less than $50 million), and 305 commercial bankers nationwide who served small, mid-sized, and large businesses.

The relative importance of the 15 factors, as ranked by owners and bankers, is shown in the table below. The factor most often chosen appears first; factors chosen less frequently are listed in descending order.

While there was some agreement, the table shows considerable differences in the ranking of several critical factors. For example, bankers expected family business owners to value their personal relationship with a specific bank manager, and the bank's community reputation, much more than the owners actually did. Bankers also expected their bank's ability to make quick decisions to have far greater impact than it did. On the other hand, banks down-played the importance of their own financial health, while 14 percent of owners ranked that factor first. Finally, banks expected owners to take friends' recommendations in selecting a bank far more seriously than owners did.

The first four factors on the owners' list were chosen much more frequently than subsequent ones. These factors—long-term relationships between a company and a bank, accommodating credit needs, delivery of services, and competitive prices—clearly dominated as choices.

Bankers ranked three of the same factors in their top four, but missed by a great margin the importance of establishing a long-term relationship. More family business owners (22 percent) ranked this factor first than any other. Another 30 percent picked it as their second or third choice. This indicates owners are concerned with sustaining a relationship with a particular bank, not a specific bank manager. This ranking mirrored the background data we took, which showed that almost 80 percent of the owners had not changed banks in the last three years and 89 percent indicated they did not plan to change banks in the next 12 months.

A clear understanding of expectations is most important for small companies—the strongest candidates for character loans. We compared the responses of the owners of small family businesses (less than $5 million in sales) with those of bankers who indicated they served this small-business market. The outcome is shown in the second table, “Bank Priorities of Smaller Family Firms,” below.

Although the owners and bankers selected two of the same three factors in their top-three ranking, there were some noteworthy differences. The owners ranked a bank's ability to accommodate credit needs significantly higher than bankers did. Conversely, more bankers than owners placed importance on competitive prices, even though both groups chose that factor second overall.

There was significant misunderstanding by bankers of the importance of relationships. Bankers ranked the ability to provide a long-term relationship sixth overall, and chose the establishment of a personal relationship as the leading factor. Owners took the opposite view; they valued the long-term relationship between their company and their bank (ranked third) significantly more than any personal relationship between an owner and a particular bank manager (ranked fifth). The difference may reflect the fact that many of the owners had been in control for more than 20 years, which is typical of family businesses, while banks often shift around loan officers and managers every few years. The family business owner is loyal to the bank, but not the banker.

It is apparent that bankers and owners can benefit from a better understanding of each others' expectations. For both groups, it is less costly in time and resources to maintain an existing relationship than to build a new one. The question arises as to why their differences in perspective exist in the first place, and how they might overcome them.

Part of the problem is that family business owners have a more complex set of needs than other owners. They have family needs as well as business needs. Most bankers are probably not aware of the interpersonal family issues that permeate their clients' businesses, nor are they privy to conflicts within family systems. Even if they do have some sense of these dynamics, they are uncomfortable with them and do not know how to address them. They are trained to look at the numbers, not talk about relationships.

Yet such understanding forms the very basis for character loans. While it might be impractical for bankers to train themselves in family dynamics, if they want to keep their family business customers they should develop a set of references—attorneys, CPAs, mediators, estate planners, and family business counselors—who can help them make judgments. Bankers can also increase their effectiveness if they integrate within their own operations; it is not uncommon for a bank manager to not know which of his officers are handling family business clients. They can sit down as a group and identify common issues and form teams to address them. Bankers can position themselves as key players among a family business's professional service providers if they learn how to understand family issues better, let owners know they value long-term relationships and understand the company's banking priorities, and become familiar with the upcoming generation.

Family business owners, for their part, have to become more willing to describe the big picture to bankers, if they have any hope of actually securing character loans. Many family businesses are secretive about the business's net worth and financial needs. They are loath to tell outsiders about their financial affairs, not to mention their personal ones. Owners must let their bankers know about their succession program. They should have the bankers meet members of the next generation, even if it is not clear who will ultimately take over. Owners must understand that they will gain leverage if they give bankers some insight into succession plans, at least to a modest degree, so the bankers will be more comfortable with the company's prospects when the actually leadership transition begins.

This accomplishes another objective. Owners put the company at risk of being turned down for a loan, especially a character loan, if they have not given the next generation the opportunity to develop as financial managers, whose skills and character are recognized by the banking community. There are many steps owners can take. If nothing else, an owner should bring along members of the next generation when renegotiating a line of credit or opening a new loan. An owner should inform his banker when children receive degrees or promotions, or when they complete advanced training. It will also help to increase the general visibility of the next generation by encouraging their participation in the community, at Chamber of Commerce or Rotary meetings, for example. This will put the next generation in direct contact with bankers and will present an arena in which the children can show their abilities and gain respect.

If owners do not encourage the next generation to form relationships of their own with bankers, when the heirs take over they will not have any track record or credibility. It is important that bankers see that there is leadership developing within the next generation. For without a willing banking partner, the family firm will have no alternative but to limit its growth. Family business owners must manage their banking relationships with care. The consequences of not doing so are too great.


Bonnie M. Brown is director of outreach at Oregon State University's Family Business Program, in Corvallis. James F. Nielsen is professor of finance at Oregon State. Rowan M. Taylor is state bank lecturer in banking at the University of Technology's School of Finance and Economics, in Sydney, Australia.

Company priorities in selecting a bank

Company view Bank view
1 Can provide long-term relationship 1 Has competitive prices
2 Can accommodate credit needs 2 Can accommodate credit needs
3 Can deliver all services 3 Provides a personal relationship
4 Has competitive prices 4 Can deliver all services
5 Is financially healthy 5 Has community reputation
6 Provides a personal relationship 6 Makes decisions quickly
7 Has convenient location 7 Can provide long-term relationship
8 Knows your business 8 Has convenient location
9 Has innovative ideas 9 Knows your business
10 Makes decisions quickly 10 Is financially healthy
11 Has efficient operations 11 Has efficient operations
12 Has community reputation 12 Was recommended by colleague
13 Other 13 Has innovative ideas
14 Prices some services below norm 14 Prices some services below norm
15 Was recommended by colleague 15 Other


Bank priorities of smaller family firms

Company view Bank view
1 Can accommodate credit needs 1 Provides a personal relationship
2 Has competitive prices 2 Has competitive prices
3 Can provide long-term relationship 3 Can accommodate credit needs
5 Provides a personal relationship 6 Can provide long-term relationship
Note: This table lists responses only from owners of businesses with sales of less than $5 million, and bankers who serve them in particular.


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Summer 1993

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