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Opportunities – and loan applications—are on the rise in a rapidly growing industry. Savvy lenders are learning more about the issues and risks in lending to individuals and companies seeking to capitalize on the Net.

Most bankers prefer to wait until an industry develops before lending any of their depositors' funds to one of its participants. The Internet, still a mystery to many of us, has developed as an industry to the point that its newest concern is how to keep the Net from crashing down from overload. Internet-related loan applications have undoubtedly been making their way to banks for many months. With estimates of 40 million Internet users worldwide, and hundreds of thousands taking the Internet plunge monthly, it's safe to assume increased demand for small loans to businesses seeking to exploit the Internet. A working knowledge of Internet-related issues will help bankers consider loans to this newest industry.

Background

The Internet was formed nearly 30 years ago by the connection of four supercomputer centers. The Advanced Research Projects Agency (ARPA), a subunit of the Department of Defense, originally developed this "network of networks" to enhance the performance of the supercomputers and provide an uninterrupted means of communication. ARPA used a theory that information could be broken into multiple packets of data and sent to the receiver through multiple channels. This distributed network meant that a broken machine no longer halted the access to other networks; instead, access was gained through the remaining open channels. Electronic mail—e-mail, invented in 1972, allowed messages to be sent across the network. For the next 19 years, continuous upgrades to the Internet were made, including increasing the size of its communication lines and adding software programs that allowed easier searching and downloading of information. Just four years ago, a lab in Geneva, Switzerland, chartered the Internet Society and released the World-Wide Web.

From the original four hosts in 1969, the Internet grew to 10,000 hosts within 18 years. From 1987 to 1989, this number jumped 10 times. The commercial focus of the Internet began in 1989 when the first relay between a commercial electronic mail carrier, CompuServe, and the Internet was established by Ohio State University.



Internet 101: Glossary

Bulletin Board System (BBS) -- a system allowing its user to (1) post messages for others to read, virtually instantaneously, and (2) read messages posted by others. A BBS usually is connected to a particular interest.

Chatting--exchanging messages with other Internet users in "real time" via the keyboard. At special Web sites devoted to active interchange among users having particular interests, users can "converse" instantly with one another. Chatting can occur among groups of users or in "private chat rooms" between just two users.

E-mail--electronic messages sent to users across the Internet. Depending on the amount of traffic and other factors, e-mail messages can be received within seconds or minutes or can take up to a day or more.

Home Page--a basic document introducing information. Web pages today often include photographs and other graphics, as well as a number of hypertext links to additional information on a particular area.

Hypertext Transfer Protocol (HTTP)--the process by which information is transferred through the network. Appearing as underlined or otherwise highlighted text, hypertext copy generally changes the look of the cursor when the user moves the mouse over the hypertext. A double-click on the mouse initiates the transfer of additional information related to the hypertext.

Newsgroup--a BBS that focuses on a specific topic.

Transmission Control Protocol/Internet Protocol (TCP-IP)--a format that allows different systems of the Internet to communicate with one another.

Uniform Resource Locator (URL)--connects the various pages of information together via addresses supplied by the person posting each site. Hypertext uses the URL to take the user to its links.

The Situation Today

Growth alone is not what keeps the Internet among the most-discussed topics in the country. The massive attraction is driven by its constant change and improvement. The most substantial change is the addition of the World-Wide Web and its browsers (services helping the user to find an organization or subject). Audio and video improvements allow the inclusion of multimedia information. More recent developments are interactive (user and Web site interact as the user makes selections from a menu of options, leading to more specific information, an automatic e-mail message to the site, or actually placing a product order).

Types of Business Loans Related to the Internet

The majority of Internet applications can be categorized into three opportunities for a business or entrepreneur.

Internet Service Provider (ISP).

An ISP purchases the equipment necessary to provide Internet access to the local community of individuals and businesses. ISPs include CompuServe, America Online, and other well established companies, plus new companies competing with lower rates and fewer frills.

Product Services Marketing

Increased marketing on the Internet is opening the door to other business opportunities. Whether creating Web pages or selling space on a Web page—like a billboard, entrepreneurs can exploit the marketing aspect of the Internet to develop a new business or increase the presence of an existing business.

Training.

Although the majority of younger users are already computer friendly, many people still need help with new concepts such as the Internet and online services.

Lending Considerations

There are many issues a commercial lender must address to fully analyze an Internet-related loan application; the number of issues varies according to the borrower's intent.

Web (Home) Page Requests.

The easiest application for a loan officer to process is one that involves an existing business trying to incorporate the Internet into its marketing and sales departments with a home page. To establish a page on the Internet, the user creates visual and textual information in a language compatible with the Internet called Hypertext Markup Language (HTML). The business can then place the document on a file server, so it can be accessed by Net users.

The business must decide whether to store this information on an established server or to purchase its own file server and Internet connection. Most businesses choose to employ an established server, but some opt to own the file server and apply for a loan for the equipment necessary to implement the project.

The information with which the loan officer must be concerned includes a summary of the company's technical ability to install and maintain a 24-hour Internet connection. If the company has no past experience, the lender should verify that the company receiving the task of installing the equipment is well versed in this area.

The lender also should be concerned with collateral. The majority of expenses for establishing a 24-hour Internet connection are soft costs, such as the installation and programming of software as well as the installation of the communication line. The equipment offered as collateral rarely equals the amount of the loan request and consists of high-tech computer equipment that has a very low liquidation value.

As with most computer equipment loans, the loan should be short term and the lender should realize that the business will incur an annual charge for leasing the communication line. The charge will vary according to the band width (size) of the communication line.

Marketing Requests.

The next type of application increases the amount of information for which the lender should be concerned because this application is for a loan to start or to expand a business focusing on the marketing side of the Internet.

The income of a business with this focus usually results from two types of sales. The easiest sale to obtain is the development of a home page for a person or company wanting to establish a presence on the Net. The second form of income stems from the sale of space on a home page developed by someone else, much like a billboard. In both cases, a business engaging in this activity must have strengths in a number of areas. Since the business is sales and marketing oriented, an outgoing sales staff is a necessity. Technical knowledge and a strong background in the Internet also are crucial characteristics to the success of the business. The final aspect required for success is graphical ability and creativity. Home pages on the Internet are judged by these criteria.

Once the lender is comfortable with the information relating to the above-listed topics, he or she should be concerned with the financial projections of income related to the total available market. The developer can realize income not only from the completion of a home page, but also from the frequent maintenance for updates to that page. With regard to home page design, there is no benchmark for what a developer can charge. The lender must keep in mind that although some people will pay several thousand dollars for the development of a complete Web site, many developers will complete complimentary home pages just to win some major accounts in the market.

Much like the home page requests already discussed, the majority of collateral usually offered is the computer equipment needed to create and store a home page. Moreover, short-term loans are better suited for this collateral and the lender may choose to pursue a government guaranty, from an agency such as the Small Business Administration or Rural Economic Development Authority, to help offset any deficiencies in the loan application.

Internet Trainer Requests.

Like a business focusing on marketing, an entity engaging in Internet training or providing access to the Internet is much more complicated a loan application than the types discussed previously. The lender considering these types of applications should be aware of several trends in the marketplace.

To be successful, Internet trainers should have access to a multicomputer training facility for hands-on sessions. In addition, these trainers should have a working knowledge of computer software and hardware that is not related to the Internet. Since diversity is the key, companies should be able to train customers on the major software and programs currently used in offices, as well as on the Internet. It is highly unlikely that a company will be a going concern for more than one or two years if it provides only Internet training to a community of fewer than 500,000 people. The major concern is the amount of training needed to break even with the monthly expenses. Other concerns for this type of application match the concerns for the marketing and ISP requests.

Service Provider Requests.

ISP requests are by far the most intricate loan applications for this industry. The lender must understand several facets of ISP to ensure success for both the borrower and the bank.

The most important facet is the ISPs ability to accurately project its break-even point and cash flow statement. This business receives income from a monthly service charge placed on each subscriber's account, usually called a dial-up account. The current market rate of this charge ranges from $10 to $25 per month and some companies include a per-hour charge for each hour connected to the Net. To develop a true break-even analysis, a lender must consider many industry-specific items.

The lender must first understand that the amount of equipment required is somewhat proportional to the number of active users. For example, an ISP must have modems to handle incoming calls from multiple subscribers. Modems may be purchased individually and stored in a "rack." The average company uses a ratio of seven to 10 dial-up accounts per modem, with the understanding that not all accounts will be active at the same time. Keeping this ratio in mind, the lender should ensure that the business plan includes enough equipment to reach the break-even sales point. Start-up companies should use the lower ratio to maintain a good status with their customers. Nothing is more harmful to the business than a customer who complains of a constant busy signal.

Also crucial to the company's future performance is the band width of the communication line. Users connect to the ISP through a telephone line that gets routed through various equipment and eventually reaches the Internet through a communication line. Communication lines are measured in terms of band width, that is, the amount of data that can be handled at one time. The minimum band width an ISP should consider is a 57,600 line, the maximum line currently available is a T3 line, the backbone of the Internet. The two lines falling in between are the ISDN line and the T1 line with T1 lines the most popular for ISPs.

The challenge for the lender is to ensure that the band width proposed in the business plan is large enough to handle the amount of customers needed to reach the break-even point. When lines become too full, communication between two points begins to slow down, and the customers become frustrated. An ISP with a break-even level of 200 dial-up accounts would not survive long with a 57,600 line because, during peak access times, the length of time between a user's request and retrieval of information would be too long.

Another point to keep in mind is that telephone charges are a major monthly expense. Depending on the telephone company, an ISP can receive a volume discount if it orders a larger number of telephone lines. To determine if this discount can benefit the ISP, calculate the number of modems needed (the number of dial-up accounts needed to break even, divided by the number of accounts per modem) and compare that with the number of lines needed for a discount.

While considering the phone system, the ISP should realize that the peak times users access the Internet are evenings and weekends. Therefore, the ISP should choose a phone service with lower rates at those times.

A loan application for a would-be ISP often includes projected income sources other than dial-up customers. These alternate sources include training and home page design. The important point on which the lender must focus is the amount of dial-up customers needed to break even. To be conservative, the lender should analyze the projections using income solely from the dial-up accounts. Most sales resulting from the alternative income sources come only after customers have experienced the Internet.

The lender should also verify that the projections stagger the amount of dial-up customers over a period of months. Depending on the size of the undeveloped market, it is common for an ISP to gain customers at a rate of 40 new accounts per month, especially around the Christmas season. In a market with competitors, however, the lender should be able to create a conservative cash flow statement producing the needed level of working capital.

Another facet requiring the lender's attention is future competition in the market. Although the current market may have no competitors, there are ISPs that provide services on a national level with competitive rates. As phone companies become more interested in the Internet, increased competition is inevitable. With increased competition, can the company survive a rate war? Will the market bear multiple providers? Questions like these are bound to occur but sometimes, the answers are almost impossible to determine. The point for the lender is not necessarily to have all the answers but to feel comfortable with the borrower's ability to resolve new challenges to the lenders satisfaction.

Much like other types of applications in this industry, collateral for the ISP is usually the equipment of the business. Therefore, loans are usually short term and are rarely fully collateralized. Personal guaranties should be a given, since the better portion of the business relies on the brain of the person with the computer/technical experience. Also, a lender is wise to pursue a government guaranty on all applications as well as to seek collateral outside the business operation. Lenders should structure loans to match the useful life of the collateral. If the lender is extremely cautious, he or she may request the business to calculate projections that include the upgrading of most equipment to ensure that the company can stay competitive as faster and easier processes develop.

To lenders nurturing a distaste for computer equipment as collateral, leasing is an option. Many leasing companies offer terms on the necessary computer equipment for this industry. Although this option reduces the amount of the loan, the business will incur the same, if not higher, expenses. The lender may feel more comfortable with a smaller loan amount and no high-tech equipment as collateral. A short-term lease also allows the company to upgrade to newer equipment with little or no out-of-pocket expenses.

Finally, lenders should remain in touch with any customers involved with the Internet. Rapid changes in the Net can quickly render a business that does not embrace new techniques or products obsolete.

Conclusion

With the ever-changing facets of the Internet, loan applicant and lender alike must be knowledgeable of current technicalities and also be able to handle swift changes in the technology marketplace.

Internet familiarity will help lenders process these loan applications better. Furthermore, existing customers who seek their bankers' advice on the Internet will feel comfortable that their lenders are keeping up with the newest innovations.

Structured and serviced properly, loans to companies involved in the Internet can be safe and profitable.
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