From the November 1997 issue of Entrepreneur

The way Bonita Schwartz figured it, being a small-business owner and a woman to boot weren't helping at all in her search for a small-business loan. But the times may be changing as new technology and shifts in the lending industry conspire to make loans available to capital-hungry entrepreneurs.

Schwartz's story dates back to 1985 when she formed Schwartz Research Services Inc. in Tampa, Florida, offering consumer research services. By 1993, business was so good, she went looking for a loan to build a focus group facility and corporate headquarters. She naturally turned first to her bank, which had all her personal and business accounts, and applied for a $350,000 loan. "When the loan officer called to ask if I had gotten the business from my husband in a divorce," says Schwartz, "I knew the loan request was going to be turned down." She was right.

The Color of Money

While small businesses and banks would seem to make a great combination, in reality nothing could be farther from the truth. The crux of the problem: Banks are working with other people's money. When customers make a deposit, they expect their money to be present and accounted for when they want to withdraw it. This puts the bank in what many lenders refer to as an "abundance of caution" mode. Simply put, this means banks won't get involved in situations where a loan is at risk, period.

This alone should speak volumes about the behavior of your typical loan officer. Still, many entrepreneurs get angry when banks don't appear interested in making loans to their small and sometimes highly risky businesses. But take a walk in the banker's shoes. If you were working with borrowed funds that had to be paid back upon demand, would you lend them to a business with a dubious ability to repay the loan? Of course not. So why should banks? They aren't built to lose money. They are, in the final analysis, running a business.

Another reason banks historically have not been fired up to lend money to small businesses is that small businesses typically request relatively small loans. The abundance-of-caution mode in which most banks operate means the analysis and disbursement of loans is a downright expensive process. The banker visits the company. Then visits again. Then reviews a loan proposal. He or she might even call on some of the business's customers or suppliers just to make sure the whole thing is for real. Then the banker submits a loan proposal to the credit committee. If it gets approved, the bank will create a truckload of documents, which the borrower will haggle over. The bank's lawyers will haggle back. Then the loan gets disbursed.

For the bank, it doesn't stop there. A loan officer will be assigned to the loan and will review the borrower's financial statements each quarter until the loan is paid off to make sure the company is not violating any covenants of the loan agreement.

The problem for small-business borrowers has been that the costs for the loan process were the same whether the borrower wanted $150,000 or $15 million. From the bank's perspective, if the costs are the same, it would rather distribute them over a larger loan, not a smaller one.

Technology To The Rescue

According to Robin Wantland, a regional executive with Bank One in Dallas and the former chairman of the American Bankers Association's Small Business Division, information technology is changing this scenario by helping banks drive down costs in three critical areas: loan acquisition, risk management and loan servicing.

Wantland says in the old days, banks were run by big mainframe computers, and data had to be hard-coded to do any kind of analysis. But with today's client server technology, it's a different story altogether. "With data stored on a server," Wantland says, "it's available to product managers, risk managers, marketing managers, customer service managers and loan officers--and it's helping them do their jobs at costs that make small-business loans feasible."

At the center of this empowering technology is the area of credit analysis. Instead of relying on traditional analysis, which is costly and time-consuming, banks are now starting to rely on the kind of credit scoring systems that credit card companies have used for years.

Fair, Isaac and Co. Inc. of San Rafael, California, a data analysis software firm, has a commercial credit scoring system that's helping to dramatically reduce bank loan approval times and costs--and thus put money into small businesses' pockets faster. Latimer Asch, the firm's vice president of commercial products, estimates banks that don't use this kind of system require 12.5 hours of human "touch time" to reach a credit decision and that the cost to reach this decision ranges between $500 and $1,800. He maintains that with his company's Small Business Scoring Service, the time required by the bank to reach a credit decision (assuming the decision is totally automated) is 15 minutes and costs just $100.

In addition to easier and less expensive credit analysis, Wantland says banks can monitor the loans with fewer resources, too. So rather than the expensive relationship-oriented model that banks once used to make sure their loans were in good shape, loan officers can now retire to the background and check a business's loan status by computer. In fact, Wantland says that if companies keep their credit records clean, the borrower will never even have to hear from the lender.

Out in the trenches, this means more loans are going to more small businesses in a more efficient fashion. In early 1996, when Bonnie Schwartz revived her dream to build her own focus group facility, it was a whole different story when she applied for a loan. Barnett Bank of Tampa, which had a branch near Schwartz's office and used a scoring model for credit analysis, approved her $495,000 loan application in just four days.

Schwartz was pleased that Barnett's credit scoring model looked at her loan proposition objectively. "What I liked about this new approach was that it didn't matter if you were a man or woman--[the bank] looked at your history," she says.

Wantland says midsized and larger companies are relying less and less on bank loans, prompting even greater interest in the small-business market. But while many banks profess an interest in small-business lending, Wantland offers these tips on how to recognize the ones that are truly interested in making loans to businesses like yours.

  • Consider larger banks. Wantland says small banks play a vital role in fulfilling highly customized needs for small businesses. But for small businesses that need a quick loan without the bells and whistles, it's the larger banks, with $10 billion or more in assets, that are capable of delivering the goods.
  • Critically evaluate product lines. Wantland, who investigates competitors' offerings all the time, says you should ask bankers what products they have geared specifically for small businesses. "If they have just one deposit or checking product, just one option on credit, or they give you a price list that is 5 years old, that's a sign the institution is probably not too serious about the small-business market--no matter what their ads say," warns Wantland.
  • Find out how long it takes to get a loan approved and how it gets approved. If the answer is two hours, you're probably looking at a bank that's serious about small business. If the answer is two weeks, you might want to keep looking.
  • Remember that ease varies inversely with size. For many loans above $150,000, automated credit scoring notwithstanding, most banks want to take a closer look at your company, and that can slow down the process. If you want a really fast loan, keep your request under $100,000.

Package Deal

The role of technology in shaping the small-business lending market has a flipside, too, which makes the prospects even brighter for small-business lending. That is, as credit analysis, approval and monitoring become more automated, small-business loan portfolios at banks will become more homogeneous. This phenomenon is a plus because it means banks will then be able to package and sell their small-business loans in the same way auto loans and mortgages have been sold for years. "When banks can make small-business loans, sell the loans and get their funds back to make even more loans," says Wantland, "it ultimately means the pool of capital for small business has been considerably enlarged."

According to Asch, this recycling of small-business loans is just starting to become visible on the horizon. "It takes a while to season a portfolio, and there needs to be a large enough volume of loans on the books to make the effort worthwhile," he says. "Plus Wall Street, which will `securitize' these debts before they are sold to investors, needs to get a better sense of the prepayment and default rates so that they may be accurately priced." But when this happens, the power of this link to the securities markets cannot be underestimated. Suddenly, investors from around the world will be funding small business, and the pool of capital available will be nearly bottomless.

David R. Evanson, a writer and consultant, is a principal of Financial Communications Associates in Ardmore, Pennsylvania.

Contact Sources

Fair, Isaac and Co. Inc., 120 N. Redwood Dr., San Rafael, CA 94903, (415) 472-2211

Schwartz Research Services Inc., (813) 207-0332, fax: (813) 207-0717