It’s All About the Collateral

I’m often asked if a business plan is solid enough to take to the bank for financing. I disappoint a lot of folks when I tell them that, while a solid business plan is important, getting loans is all about the collateral.

Banks are not in the business of understanding your business. They don’t know how to evaluate a broadband business plan. It’s important to understand that in a given week a bank might be offered your broadband business plan, a plan to roll-out a dozen yogurt stores, a plan to combine several farms, and a plan to start a new brewery. They can’t begin to be able to understand the nuances of the many business plans they see.

It’s very easy to become too invested in your business plan. I often hear people describing their business plan as ‘can’t fail’. I can usually demonstrate that this is not so by changing a few of their key assumptions. It’s the rare broadband business plan that can’t be worsened by lowering the customer penetration rate, slowing down the speed of sales, or increasing the interest rate on debt.

Banks understand this. Every bank has a portfolio of failed projects where the bank lost a lot of their loan investment even though a project looked solid. Banks are skeptics by nature because they deal all day with prospective borrowers who are convinced that they are bringing a no-fail project. If a loan is large enough, a bank might hire an expert like me to check the assumptions in a business plan to help to identify the most sensitive variables. However, even with expert advice, a bank is still going to assume that a business can fail.

That’s why I say that the most important thing is collateral. Collateral represents the ability of the bank to recover some of their funds should a project fail. The stronger the collateral, the easier it is for banks to make the loan.

There are various types of collateral. The best collateral is a payment guarantee that kicks in even should a project be a total bust. This is the reason why municipal bonds that are backed by tax revenues can get lower interest rates. If a city builds a fiber network, a golf course, or an arena and the expected revenues don’t materialize, a tax-backed loan requires the city to raise taxes to make the bond payments.

Many new ISPs become familiar with the idea of collateral when banks ask them for a personal guarantee, meaning a borrower must pledge their home and savings as back-up for a project. That guarantee is rarely as powerful as tax-collateral, but it improves a borrower’s chance of getting the loan.

Established ISPs also face loan guarantees. If a telco wants to undertake a large new fiber project, they generally end up pledging their entire existing company to get the new loan. Communities often wonder why existing ISPs don’t expand faster, and more often than not it’s because they’ve already used up all of their collateral on existing loans. Just like with households, every business has a natural lending cap, at which no bank will loan them more.

Banks do consider other issues other than collateral. For example, a bank might consider track record when lending to an ISP that has been successful many times in the past – and that track record might lower the needed collateral. Banks love grants, but love owner equity even more since it means the owner has skin in the game.

Occasionally I see a new fiber venture that gets funded when it probably shouldn’t. There are local banks that lend to a local fiber project because they think their community needs fiber to thrive and survive. A bank in that situation is putting themselves on the line since they see their survival tied to the survival of the community.

The bottom line is that a project without collateral is not easily bankable. Unsophisticated borrowers think the numbers in their business plan tell a bank all they need to know. The truth is that the business plan is several items down the checklist for a bank, with collateral at the top of the list.

The Evolution of the Fiber Business Plan

Fiber CableThe other day it struck me how much the telecom consulting business has changed over the last decade. A decade ago a huge amount of the focus of an FTTP feasibility study was about integration. And today all of the emphasis is about finding the money to pay for fiber.

Integration is the effort required to make the equipment from different vendors work together. In the early days of the FTTP industry this was a very big deal because there were different issues with every brand of electronics in the industry. There was nothing at all automatic about getting a cable TV headend or telephone voice switch working on a given fiber network.

A lot of the work involved in choosing a brand of electronics was deciding which brand had the least number of bad things that wouldn’t work on an FTTP network. There was a time when very basic things like supporting a fax line or provisioning a T1 on FTTP was an issue. There were tons of problems getting some telephone features to work. And no matter what the vendors told you, when it came time to get a new network up and running all sorts of new surprises would pop out after each new software release from the many vendors. It got so bad that we were recommending not updating software at one point.

Sometimes the integration issues were significant. I had one client who was the first one to try an IPTV cable headend on their FTTP network and they had a huge number of headaches. The integration caused them a delay with their launch and their problems with cable delivery were so bad that they got a bad name in their market that took years to overcome.

But today there is almost no worry about making things work on an FTTP network. Most products are now delivered as native Ethernet and all of the work of decoding the signals is done by smart devices like set-top boxes or modems rather than in the fiber electronics. I can’t recall having used the word integration for many years, which is refreshing compared to a time when we had to practically scare clients to make them understand that they were going to see surprises and have delays every time they launched a new product on their network.

Today we are able to make a pretty reliable estimate of the cost of the electronics and know that when it comes time to get into the business that whatever major brand of electronics is chosen will work well.

Today our emphasis has instead turned towards figuring out how to pay for building a fiber network. This has never been easy, but it seems like all of the old avenues of financing – be that bank loans or municipal bonds – are harder to close these days than in the past. In the last fifteen years banks have tightened up significantly compared to the times before the housing meltdown of a few years ago. And municipal bonds for fiber are a harder sell due to a few failures of municipal revenue bonds for fiber as well as a tougher bond market in general.

I find that I spend far more time these says working on financing and as a firm we spend far less time working on engineering issues. I now warn clients that funding will be the big hurdle where in the past it was the worry of successfully getting all the products to work right. I now put a whole lot of emphasis up front with a new client on finding a business plan that they can take to the bank. I know that bankers are going to scrutinize every assumption and that there has to be a lot of safety margin in any business plan so that it will remain solvent even if it does worse than hoped for.