Small business grows on borrowed money. I’m not talking about idea-stage or startup companies right now. I’m talking about the Main Street businesses you and I rely on when we go out to dinner, drop off our dry cleaning, or need our car repaired. Small business financing keeps the company growing.
Not too long ago I spoke with a florist from the Bay Area. He had a thriving business with multiple locations when the bottom fell out of the financial markets. As credit tightened, his bank revoked his line of credit. He was on top of his bills, wasn’t a deadbeat by any means, they just didn’t want to extend him credit any more. As a result, he metaphorically circled the wagons and decided to wait things out. Although his business continued to “maintain” its place in the market, he wasn’t able to grow.
It’s a common tale.
The good news is, he was recently able to acquire some needed financing to fund expansion plans—he just didn’t get the money from the same place he would have five or six years ago. It should be no secret to most Main Street business owners looking for money, it’s hard to get. It’s particularly hard for the smallest small businesses. Over the last 10-15 years banks have been moving upstream to bigger, more stable, and supposedly more profitable fish, leaving the small businesses you and I identify with the most scrambling to find cash.
Pepperdine University’s Private Capital Access Index for the second quarter of 2013 suggests that although 59 percent of small businesses owners look to their local bank for funding, most of them get turned away empty handed. Only 27 percent of them (and I think this is a generous sampling) leave the bank with a loan. Some studies suggest the number is much lower—only 10 percent. Most people, 71 percent, find success with friends or family.
In fairness, there are some banks who are still engaged in small business financing. And, the recent decision by the SBA to eliminate the fees associated with small business loans of $150,000 or less is a move in the right direction, but even a $150,000 loan is out of reach for many of the smallest businesses. Right now, small business loans of $50,000 or less are just too expensive for banks to process and frankly aren’t that profitable for them. In 2012 the average SBA loan was a little over $300,000 and it’s almost $400,000 for this year. Way beyond the $50,000 or less that 59 percent of the business owners that come to Lendio are looking for (and those numbers are very consistent with other organizations that focus on small business financing).
Today, the lenders most engaged in small business financing focus on specialty loan products that fill specific niches for small business owners. For example, there are lenders that specialize in commercial real estate loans, accounts receivable factoring, merchant cash advance, or equipment financing. Some of these services might be offered at your local bank, but most probably won’t—the average loan sizes are too small. I’ve spoken with a number of these alternative lenders over the last few weeks who have shared that their average loan sizes are somewhere between $25,000 and $50,000, depending on the lender. Not unlike what we see at Lendio, far below the average SBA 7(a) loan.
Most of the lenders I speak with regularly are sympathetic to some of the challenges Main Street business owners have had to deal with over the last few years and are willing to talk about why a small business borrower might have a less-than-perfect credit score, rather than dismissing them out of hand. Small business owners who can demonstrate improving business conditions and an ability to pay back the loan, are often able to get the financing they need.
If there is a down side, it’s the cost of capital. Yes, interest rates on these products are higher than they would be on a business line of credit or a small business term loan. Unlike the community banker, whose cost of capital is so low it might as well be zero, that isn’t true for the alternative lenders we’re talking about. Although the interest rates are higher, they’re not as high as some of the alternatives—using a personal credit card, for example.
A low interest loan geared to help small business owners might even be considered the Holy Grail when you consider that less than half of the small businesses we’re talking about make it to their tenth birthday, many have credit problems, and the lenders anxious to lend to them also have a higher cost of capital than the local bank.
I’m not sure we’re going to see this change anytime soon either. The smallest small business owners are going to continue to struggle finding capital at the bank, but as more and more alternative lenders enter the space, competition will continue to drive interest rates down and it should be easier for Main Street to get a small business loan—putting the Grail more in reach.