Microfinance Hits Small Businesses Right Where It Helps Here are three reasons why micro-borrowers do better than owners who've borrowed from a traditional bank.

Venture capital is the hot, sexy funding route that annually helps a small number of businesses and grabs a lot of headlines. But behind the scenes, it turns out another type of funding works out better for most entrepreneurs: Microfinance, small loans of $25,000 at most.

Non-bank lenders such as Accion USA and the San Francisco Bay Area's Opportunity Fund provide loans that average just $7,000. Here's the funny part: These lenders report the businesses they lend to have a survival rate that's twice the national average. Repayment rates are on par with traditional banks, too.

Next week, microlenders will meet in New York for the second annual Microfinance USA Conference, to celebrate the successes and spread best practices around the microfinance industry. Speakers will include Citi's global director of microfinance Bob Annibale, and Daryl Collins, from Bankable Frontier Associates, who's a co-author of Portfolios for the Poor, study of how the impoverished manage their money.

It's a particularly well-timed meeting this year, as there's never been a better time for microlending to grow. Banks continue to struggle to serve business owners' needs – in the third quarter of 2010 small business loan balances continued to decline at an annualized rate of 13.3 percent from the end of the second quarter, according to the the Federal Reserve Bank of Cleveland. And funding your business with credit cards can be hazardous.

Why do micro-borrowers do better than owners who've borrowed from a traditional bank or used plastic? I can think of three reasons:

• Better vetting. Microlenders tend to spend more time getting to know a business owner one-on-one -- something that usually doesn't happen at major banks. These microlending institutions often take bigger risks on unproven startups. But because they take the time to learn a lot about the person seeking the loan, they form a more personal connection. I've spoken with Accion in the past, and they stay in close touch with their borrowers. With the closer ties they forge with borrowers, entrepreneurs often don't want to disappoint the person at their microcredit lender who approved their loan.
  
• Support groups. Most microloans are made in a group setting. The business owners in a lending circle support each other and, in some cases, are financially responsible for each other's loans. This web of interconnected responsibility helps keep the business owners on track, lends moral support and gives entrepreneurs another set of people they don't want to let down.
  
• Small loans. When entrepreneurs only have a small sum on which to start their businesses, they watch every dime carefully. Too often, landing a big venture-capital round leads to profligate and wasteful spending rather than growth and productivity. Small borrowers also don't get delusions of global domination -- they take it one careful step at a time, so they don't stumble in over-expansion.

Will your business seek a loan this year? Tell us about where you might borrow.