It’s likely no secret to any small business owner that finding a loan at the bank is tough—approaching impossible. That’s not to say there aren’t community bankers who are invested in lending to the small business owners in their community, there are. Holladay Bank & Trust in Utah is one example. Nevertheless, a report issues by the Federal Reserve Bank of Cleveland released a couple of months ago identifies what they suggest are the reasons lending is down.
- Demand is down: “Bankers say that the main reason small business lending is lower than before the Great Recession is that demand has fallen. Small business owners, they argue, aren’t expanding, depressing the amount that the small business sector needs to borrow.”
- Small businesses are less creditworthy than they used to be: “Fewer small business owners have the cash flow, credit scores or collateral lenders are looking for. According to the latest Wells Fargo/Gallup Small Business Index, 65 percent of small businesses said their cash flow was “good” in the second quarter of 2007, compared to only 48 percent in the second quarter of 2013.”
- Lending standards have tightened: “Loan standards are now stricter than before the Great Recession. In June 2012, the Federal Reserve Board of Governors asked loan officers to describe their current loan standards ‘using the range between the tightest and easiest that lending standards at your bank have been between 2005 and present.’ For nonsyndicated loans to small firms (annual sales of less than $50 million) 39.3 percent said their standards are currently ‘tighter than the midpoint of the range,’ while only 23 percent said they are ‘easier than the midpoint of the range.'”
I’m not sure I agree completely with the Federal Reserve, but I think it’s a matter of perspective—particularly when we’re talking about Main Street. Here’s why I feel that way:
- I’m not convinced demand is down: Judging by the number of potential small business borrowers that visit Lendio every month, demand seems to be steadily increasing. Of course we’re not talking about the same multimillion dollar small business the Federal Reserve in Cleveland is talking about. Although we do see some of the borrowers the Fed is talking about, we’re generally talking about the dry cleaners, mechanics, and local restaurants that are looking for $10,000, $25,000, or $50,000 loans that are under the radar of most banks. I see strong demand, just not in the categories many banks like to work in.
- I agree that credit worthiness is a problem: The last few years have been tough and small business owners need to shoulder some of the blame associated with a lack of small business lending. That being said, there are lenders (some of them are even banks) who will discount problems over the last few years if a business owner can demonstrate they are a healthy business now and have a plan for growth. The cost of capital might be a bit more expensive, but there are alternative lenders willing to work with a small business owner with a less than perfect credit score.
- Lending standards for the smallest small businesses have a stranglehold on growth: Although big businesses and even some of the bigger small businesses have seen a loosening of credit, the smallest small business have not. Over the last couple of years we’ve seen a number of alternative lenders enter the space that once was filled by community banks.
If you have the ability to get a low interest loan from the bank, that’s where you should likely go. Unfortunately, that leaves about 90 percent of small business owners with a need to find capital someplace else. For small business owners willing to accept a new paradigm, there are numerous options available, here are just a few of them:
- Factoring: Once considered a financing means of last resort, factoring has become more accepted by small business owners and their customers. You should know it’s the financing method of choice within the textiles industry and is one of the oldest financial instruments. Technically not a loan, a ‘factor’ basically purchases your accounts receivable at a discount and collects directly from your customers. Terms vary depending on the industry your in, the creditworthiness of your customers, and how old the invoices might be, but if you’re looking for short-term cash and have receivables you can leverage in this way, it is a popular way to fund a new contract or other opportunity.
- Merchant Cash Advance: If your business is a retail business that accepts credit cards, you’ve been in business for at least a year, and have regular and repeatable credit card transactions (usually $2,500 or more per month), this might be a worthwhile financing vehicle.
- Equipment Financing: Most alternative lenders focus on specialized lending products. If your expansion need requires new equipment this can be a good way to obtain funds. You can often use currently-owned equipment as collateral for other loan purposes.
- Business Acquisition, Franchise, Peer-to-Peer, Real Estate, and other loans: Over the coming weeks and months we’ll dive deeper into many of the alternative financing available. This type of financing might be more expensive than a traditional term loan at the bank, but it’s safe to say that small business often only grows when borrowed capital is available. When you consider that many of these alternative financing methods are less expensive than utilizing personal credit cards, I believe they are worth investigating.
Although many of these lenders don’t require the same documentation that might be required by your local banker, I think it’s still a good idea to spend some time preparing to talk about your current financial position—most lenders will want to know that you have your ducks in a row. Preparing for your visit with a lender often makes the difference between getting a small business loan and leaving empty handed.
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