Why Isn't Access to Credit for Small Business Improving in 2015?
The economy is improving. Consumer confidence, although still volatile, has returned to pre-recession levels and business confidence has rebounded to near-record highs. A majority of small business owners anticipate revenue and profit increases in 2015. So, why isn’t small business access to credit improving accordingly?
In that piece last year, I expressed concern about the "choke point" in small business financing. I'm still concerned. The 2014 Year-end Economic Report of the National Small Business Association cites an uptick in small business owners’ overall positivity about the economy, but also notes that “nearly one in five small firms cannot meet increased sales demand due to inability to garner financing.” Perhaps the most appalling statistic I’ve seen recently is that 50 percent of small businesses ($250,000 to $1 million) received none of the financing they had applied for in the first half of 2014.
The relationship between credit and growth is particularly significant for small businesses. The NSBA survey reveals that 47 percent of the businesses denied credit were forced to delay business expansion. Twenty percent of small business owners relied on credit cards and business earnings to finance their credit needs. Other businesses delayed hiring.
It confounds me that in a year of record lending by the Small Business Administration, entrepreneurs still struggle to get the financing they need even when all indicators point to the opportunity for growth. In a positive move, the SBA recently launched the LINC program, an online matchmaking service that helps connect creditworthy small business borrowers with interested lenders. You start by filling out a simple online form to answer 20 questions. Your completed form is sent out to LINC’s network of local, statewide and national lenders, and potentially puts you on a fast track to consideration and approval.
But if you are denied traditional bank financing, don’t give up! Follow the lead of many of your fellow entrepreneurs, who are finding funds through well-established financing alternatives. In fact, my own company, Guidant Financial, created a tool for entrepreneurs to pre-qualify online for traditional and nonstandard forms of small business financing. Here’s a look at some of the most common:
How it works: Online lenders are a fast-growing presence in the small business lending landscape. The applicant fills out an online application that typically takes less time than a traditional bank application, and the online lender processes the applications much more quickly -- sometimes in a matter of hours. These lenders typically use one of three models: a balance sheet model with a risk algorithm that includes nontraditional data; a “lender-agnostic” marketplace model that connects you with a variety of lenders; or a peer-to-peer funding platform.
Best candidates: Businesses with good current cash flow or other solid business performance indicators, even if the owner has a lower credit score or lack of collateral.
Downside: Be aware that these loans can come with higher fees or shorter repayment terms than traditional bank loans -- and generally aren’t meant for startups. Also, online small business lending is still largely unregulated. Borrowers should be sure to check the bona fides of any online lender they approach.
How it works: Lenders offer revolving lines of credit with no collateral required, based on the entrepreneur’s personal credit history. The borrower has the flexibility to draw against the funds as required, pay back and then draw again as needed.
Best candidates: Entrepreneurs with excellent credit scores and credit history.
Downside(s): Fees and interest rates can be high, and the owner is required to provide a personal guarantee.
ROBS (rollover as business startup)
How it works: Through a rollover as business startup arrangement, the entrepreneur invests up to 100 percent of his or her retirement assets into a business or franchise without taking a taxable distribution. This provides immediate capitalization to a new or existing business with equity -- not debt. That means there are no interest payments or specific repayment timelines.
Best candidates: Risk-tolerant entrepreneurs with sufficient retirement assets.
Downside: Navigating the specific tax and ERISA rules requires the assistance of a qualified ROBS provider. As with any investment, there is the potential for loss.
How it works: A business sells a set percentage of its future revenue to an investor in exchange for a capital investment. Rather than making fixed interest payments each month, as with a traditional bank loan, the business’ repayment amounts fluctuate each month, with ebbs and flows in revenue. If a company collects no revenue in a month, for example, it won't make a payment.
Best candidates: Businesses already generating revenue but without the hard assets or proof of profit needed for a bank loan. Companies with unpredictable revenue or those that don’t want to give up equity to an investor will also do well with revenue-based financing.
Downside: Because of the instability in monthly payments, interest rates for this method can be quite costly -- between 18 and 30 percent.
How it works: An individual or institutional investor chooses to lend money to a business directly, bypassing banks. This method can provide borrowers with access to capital they may not have received through more traditional means, and higher returns on investment for lenders than they would get from a savings account. Lending platforms like Prosper and LendingClub offer an online marketplace for peer-to-peer lending, connecting borrowers with lenders.
Best candidates: Entrepreneurs with a good credit history who have been rejected for funding from traditional sources.
Downside: Watch for higher interest rates and shorter terms on peer-to-peer loans, in addition to a more rigorous and intensive itinerary required from both parties to secure the loan.
Merchant cash advance
How it works: The lender offers a fast cash advance with no collateral. The borrower repays the advance and loan fee by allowing the lender to take a fixed percentage of business credit card sales each day until the entire amount is repaid.
Best candidates: Any business with a high credit card cash flow, regardless of collateral, limited business rating or poor credit.
Downside: Fees can be extremely high, and average repayment time frames are limited (generally about nine months).
Not every alternative financing method will be right for every entrepreneur. But with so many new models becoming available, and so much evidence that small business is good business, it’s worth exploring your options. Make sure you have a solid business plan, research the alternatives and find the capital you need to launch your business or help it grow.