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Small Business Lending – Lender Beware And Other Advice

Mary Ellen Biery
November 20, 2017
Read Time: 0 min

Guest Post

By Christopher G. Webbe
Senior Consultant, CEIS

Some years ago, I worked in the credit department of a New York bank. Having expressed interest in getting involved in C&I lending, I was given a small business portfolio to manage. One of the borrowers “Jim’s company,” was part of that portfolio. The company designed and distributed teen fashions. He purchased the rights to some cartoon characters and his business consisted of designing clothes around these characters, getting the clothes manufactured in the Far East and having them shipped to his warehouse in the US. He then distributed them through clothing companies with stores in malls catering to teenagers. My bank would open letters of credit on behalf of Jim’s company to finance the imports, and then finance his sales to the stores.

A potential problem of lending to someone like Jim is that you are entirely in his hands. He will do what he thinks is right for his company. In C&I lending, your customer’s risks are your risks, and the extent to which they decide to take risks and the way in which they manage those risks will determine whether or not they service their debt.


Know the small business borrower

The more you know about your borrower, the better the position you are in to determine whether you can rely on them to make sensible decisions. During your due diligence, you will therefore want to take a good look at the borrower’s track record in business and with the bank (for that reason, lenders are usually reluctant to lend to start up operations).

One of the first things you are going to ask for is the borrower’s financial statements. However, with small businesses it may not be so simple. The quality of your analysis is only as good as the financial data on which it relies, and small businesses may not chose to invest in audited or even reviewed financial statements. Rather, when you receive financial statements from a small business, they most likely will be the result of a collaboration between the principal and his accountant. You may well have no cash flow statement, just a profit and loss and a balance sheet, and you will probably have no explanatory notes. That’s what I used to get from Jim, and I could never be sure of whether they were a true reflection of the company’s financial status.

Whatever level of comfort you do obtain with the financial statements presented, you will be well advised to make contact with the customer’s accountant. With a few judicious questions you should be able to determine how good the accountant is and how well he knows his client’s business.

An additional word on financial analysis – the riskier the business, naturally the more comprehensive you will want your analysis to be. Yet on the other hand, with the size of loan we are talking about, the profitability of individual relationships is going to be limited, so overheads need to be kept within bounds. Credit analysis is useful but in small business lending, my initial focus will still be on the competence of management.



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Watch for other sources of risk

Small business lending is complicated enough in the first place without adding an extra layer of risk. Some other activities I found in my portfolio that posed additional risk:

Restaurants and catering – During economic downturns when discretionary income becomes scarce, restaurants are often the first to suffer. Restaurants, especially individually owned small restaurants, rarely have a strong capital base so there is little to cushion them against the hard times.

Construction – As the recession hits the demand for new housing plummets. Most of the typical small house builder’s capital will have been tied up in his most recent project, and if it is a spec house and he has to reduce his price he may not be in a position to continue in business.

High Tech – Any business involved in the production and/or distribution of high-products may be at continual risk from obsolescence.

Perishables –Where companies handle food, there is the ever-present risk of spoilage.

Seasonal businesses – Any company that depends on selling the bulk of their goods or services during one or more specific periods during the year presents additional risk.

Contract work – Contract work brings with it a number of uncertainties, including whether the company can organize its bids to achieve that steady flow, how good the company is at calculating costs and ensuring the outcome is profitable, whether the contract can be completed on time and whether the company can achieve the required level of quality of work.

This is not an exhaustive list but it shows certain specific activities can involve significant additional risk. If you are going to lend in these areas, don’t go with a potential borrower that you are not sure of.

Rather, be very selective with who you go with, look at financial statements with skepticism, and be ready for just about anything.

Christopher G. Webbe is a senior consultant with CEIS and had over 30 year experience as a commercial banker and consultant. He provides loan review services for domestic and international portfolio segments. He was formerly associated with Park Avenue Bank in New York; Banco Rio de la Plata, New York Agency; Daiwa Bank Limited, New York; and Lloyds Bank Limited, New York Office and London Office. Webbe graduated from The Leys School, Cambridge, and Cambridge University (MA Honors). 

About the Author

Mary Ellen Biery

Senior Strategist & Content Manager
Mary Ellen Biery is Senior Strategist & Content Manager at Abrigo, where she works with advisors and other experts to develop whitepapers, original research, and other resources that help financial institutions drive growth and manage risk. A former equities reporter for Dow Jones Newswires whose work has been published in

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