New Options for Small Business Lending—Business Fuel Podcast #54
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The nature of where small business owners find capital is changing. Organizations like Brendan Ross’ is making a difference with the smallest small businesses. Join our conversation about where to look for cash, the role of the SBA, and how capitalism will always find a way. There are options for small business owners looking for capital and this week we talk about where capital is available and how to best prepare to apply for a small business loan.
Information you need, the podcasts you trust, this is the PatrickWiscombe.com podcast network. Bringing you interviews with top business professionals and business financing tips to fuel your American dream. This is The Business Fuel Podcast heard exclusively on Lendio.com. And now, here are your hosts, Ty Kiisel and Patrick Wiscombe.
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Patrick Wiscombe: This is The Business Fuel Podcast. Good morning, I’m Patrick Wiscombe. Thank you for tuning us in and taking us along wherever and however you’re accessing the podcast today. Coming up today, we will be talking with a small business lending expert, Brendan Ross. He is the President of Direct Lending Investments which is based in Los Angeles. But first let’s bring in the producer and co-host of the podcast, Ty Kiisel. Let’s discuss your Forbes article this week.
Ty Kiisel: Thanks Patrick. As of October 1st, the SBA eliminated the origination fees and guarantee fees on small business loans of $150,000 or less. I think it’s a real boon for the smallest small business owners. If a $50,000 loan costs the bank the same in paperwork and hassle as a $500,000 loan, which loan are they going to write? They’re going to go after the big fish. It’s not perfect, but it’s a step in the right direction. So that’s what I’m talking about on Forbes today, and that’s kind of what we’ll be talking to Brendan about today.
Patrick Wiscombe: You can see Ty’s article on Forbes.com. Just search for his name, Ty Kiisel. Let’s get to our guest, Brendan Ross, President of Direct Lending Investments. How are you this morning?
Brendan Ross: Doing good thank you.
Ty Kiisel: The SBA has been in the news quite a bit lately. They really aren’t helping the smallest small business owners. Would you agree with that Brendan?
Brendan Ross: I would. Since the 1990’s, banks have been exiting the small business lending space. Banks have had about a 40% decline since the 90’s in their small business loans. The SBA, as we know, doesn’t make loans, it guarantees bank loans. So you have an organization that’s doing it’s best, but it’s one step removed from the lenders. And those lenders have really seemed to have lost their interest in helping small businesses.
Ty: J.D. Harrison wrote in the Washington Post that as small business lending is going down, big business lending is going up. If we know that 2 out of 3 jobs in the US are in these small businesses that are strapped for cash, it seems like we’re going in the wrong direction.
Brendan: It’s ironic that we’ve used the phrase, “credit crisis” to describe what happened in 2008 and 2009. Because it feels to me, as a lender to small businesses, like the real credit crisis is the one facing small businesses today. Exactly where can they get cash? It’s not an easy equation that most conventional banks are willing to solve.
Ty: At first this may sound like horrible news. But there is light at the end of the tunnel in the form of alternative financing, wouldn’t you say?
Brendan: Capitalism will always find a way. We’ve seen the emergence of lenders and brokers help potential borrowers find their way to the correct lender.
Ty: The average main street business owner isn’t looking for $250,000. He’s looking for $25,000-$50,000. What is happening in the market to make the kind of capital available?
Brendan: If you look on the downside, the first thing that happened is people are having a hard time accessing home equity lines and credit cards. So there’s been a need to fill that gap. In the past few years, it’s begun to be filled by traditional term loan providers that operate outside the traditional banking system, but are delivering standard types of loans. These companies are small; they’re operating off their own balance sheets. So that has created a secondary need for people who specialize in finding the right lender for each borrower. That’s something Lendio does well. That’s kind of the ecosystem. So we have helpers, like Lendio. Then we have lenders, folks like OnDeck and IOU Central, each with their own type of lending that they prefer to do. Then we have folks like my fund that look at those lenders and decide which of those lenders they would like to be buying loans from. So what’s happening outside the entire banking system, we’re able to connect small business borrowers to investors that want to own small business loans.
Ty: Since 2011, we’ve seen lots of new lenders coming into the space. Do you think the way small business lending happens will drastically change in the future? Or do you think it will eventually settle out and the community banks will come back into the space? What do you predict?
Brendan: If I look in my crystal ball, I see more different types of loans coming rather than fewer. That means there will be a proliferation of different types of lenders. And probably a continued role of brokers that help the borrowers find the right lender for them. I definitely do not see community and local banks coming back and making these loans.
Ty: How do you think the whole crowdfunding thing is going to happen? In the past couple of weeks there have been a couple of SEC rulings that make it easier for the smallest small business owners to get on a platform and find money that way. Do you think that’s a long term impact in the market, or is that going to just come and go?
Brendan: Crowdfunding is here to stay. The challenge for small business owners is that crowdfunding is generally on the equity side of the equation. Which means the person who understands the business best is essentially taking on business partners through the crowdfunding process. That will be attractive to the people who need capital and have the least track record. They will find taking on equity capital will be a viable path for them. But my suspicion is that the type of person who likes to control their own destiny, is not going to be as attracted to the equity side of the equation. They’ve probably already had equity offers. That won’t be as attractive as a known debt where you create an obligation for yourself. Then the business remains 100% yours.
Ty: I look at it as a cost of capital question. What’s your take on it?
Brendan: Banks would like to loan your own money back to you. They would like you to stockpile something, lumber, washing machines, whatever. And then they would like to give you an inventory line of credit against that. But this country has become a country of service industries. Service businesses are going to be underwritten on how they’ve done historically and whether or not the owner is a good personal credit risk. Those types of businesses are going to find themselves unable to borrow from traditional banks.
Ty: Half of small businesses are gone in 10 years. It makes sense that the taste for risk is going to be a little bit higher to lend to small businesses and banks are traditionally risk phobic. If you’re a small business owner, how do you balance the riskiness to make a loan more feasible?
Brendan: First, the small business owner should think about what they’re going to be using their capital for and approximately what their gross margins are. Let’s say you make garage doors. You make that door for $100 and sell it for $140. In that case, you can borrow $120, make and sell the door, and put a little money in your pocket. Now you have a mental model of how you can borrow money and pay it back. You have to have a sense that the capital is going to translate into a work product that’s more valuable than the loan you’re going to be paying back. Second, continue to work the relationship with your bank in a way that does you as much credit as possible. You don’t want to have NSF’s, you don’t want to have days that are negative, you want to try to keep reasonable balances. Your bank account is the only reflection a lender can have of how you live your business life. It’s important that you think about that bank account as something someone is going to be looking at and trying to get a feel for how you do business. Third, we all know how important it is in this country to make good on your debts. No lender is going to hold certain types of failed obligations against a borrower. But for the most part, the credit report is a reflection of that borrower.
Ty: A few years ago if you went bankrupt, it was like a clean slate. Is that still the same way a lender is looking at a business owner or are they more willing to take someone who has struggled and made good? How do you view that?
Brendan: We most want viable businesses that have no trouble producing the cash flow necessary to pay back the loan. In the very beginning, the business is most likely going to have to be bootstrapped in some fashion and needs to show some promise. It’s built into the DNA of most Americans to pay back debt, especially that of a company who has lent you money.
Ty: How are you selling the idea that the cost of a loan is higher, but this is why it’s good.
Brendan: I’m honest with my investors. I tell them the reason they should invest in my fund is because small business owners pay the most to borrow money relative to any other group of borrowers in the United States. I really am part of the solution, but recognizing I am a participant in a market and it’s tough on the small business owners. Amortizing loans can be deceiving, the interest rates are deceiving. You could have a loan with a 20% interest rate. On a $100,000 loan, over the course of the year, you’d only be paying back $110,000. Now it’s starting to feel a little less threatening. Sure the interest rate sounds high, but you do have a year to pay back something that’s half that interest rate. I think that’s very doable. Small businesses have good margins. And small business owners work hard.
Ty: How can I prepare to be the best borrower possible? And what types of financial products should I be looking for?
Brendan: They type of product you want to look for depends on the type of cash flow you anticipate getting from the investment you will be making. Say you bring in the money and put a roof over your head. That roof will be something that will last many years. Ideally, you want to pay a small amount back over a long period of time. Or let’s say you buy a piece of equipment and you expect to get benefit immediately. In that case you’d want a shorter loan so you can pay back the loan quickly, and then start making the money for yourself on the equipment. Especially think about the term and the purpose of the loan.
Ty: It sounds like what we’re describing could be potentially better in the long run, instead of a “one size fits all” financial approach to small business loans. We’re going to be more focused on specialized products for specific purposes. Is that what you’re seeing and does it bode well for the future of small business lending
Brendan: Yes. For each borrower, you want to have a lender or lending product. I think what we will see on the equity side of crowdfunding if the different types of models that evolve. It may be we will have some things to learn. Things like prefered shares for big companies have been like having another form of debt. We may see that type of thing evolve to where debt and equity sort of meet in the middle. It’s information technology that’s allowing these different types of loan products to be made available. This wasn’t possible when the internet first came to be. We’ll see how supply meets demand for money for small businesses in new ways.
Ty: To wrap up, tell us about Direct Lending Investments.
Brendan: I founded Direct Lending Investments because I believed small businesses owners needed more alternative sources of capital. The fund that I created was an attempt to take money from investors and work with established lenders and bring that money into the equation to lend to businesses. I’ve funded about $17 million in loans to date. The portfolio is smaller than that because the loans repay very quickly. We do 6,9,and 12 month, daily and weekly amortizing loans. The returns aren’t something I can talk about to the media, but they’ve been substantial and I think the investors have felt good. The minimum investment is $100,000. The product I created is a matching of the investors need for income that is much greater than what they can get from bonds and even equities. And what the borrowers need is the capital. So I think Direct Lending Investments is doing a good job of putting those two groups together and making something that is much greater than the sum of its parts.
Ty: Thanks Brendan. We appreciate you sharing your expertise with us.
Brendan: Ty, Patrick, thank you so much for having me.
Patrick: Let’s give out the website before we end.
Brendan: Sure. It’s Dirlend.com.
Patrick: Our thanks to Brendan. You can also see what Lendio does at Lendio.com. Also check out the writings of Ty Kiisel on Lendio.com/blog. So for Brendan Ross, Ty Kiisel, I’m Patrick Wiscombe. Be sure to pick up the podcast every Tuesday on Lendio.com. Thanks for listening. We’ll talk to you next week.
Bringing you interviews with top business professionals and business financing tips to help fuel your American dream. This has been the Business Fuel podcast, with your hosts, Ty Kiisel and Patrick Wiscombe, heard exclusively on Lendio.com