Access to capital for small businesses still remains as dry as James Bond’s vodka martinis.
Banks continue to keep their vault doors shut tight. And, given that the portfolio of commercial loans in this country is teetering on a knife’s edges, who can blame these financial institutions for showing caution as these commercial loans can, at any moment, turn toxic (following the lead of all those subprime mortgage loans that trusted us into this financial crisis some two years ago).
But, like the knife’s edge that these loan portfolios are balancing on, the economic recovery that is scarcely showing signs of life is also hanging on by a thread.
Any recovery in this country will only be lead by small businesses. It is small businesses that have the greatest impact on community development, hiring, growth and wealth creation. And, when communities at large get lifted up by the very same members who reside there, all those within those communities benefit – all groups, not just a select few.
However, when it comes to lending, given our current underwriting models, it is also these same small businesses that encompass the greatest amount of risk to banks, or so they say. But, maybe this greater risk is tied more closely to the method of underwriting than it is to the borrowers themselves.
Banks and other financial lenders have essentially used the same underwriting guidelines or criteria for centuries. At the beginning of the loan process, lenders tend to analysis a borrower’s past performance to gauge how each borrower will perform in the future; sometimes with very little understanding of where that borrower may ascend to at some future point in time. Further, while most regional or national banks have taken strides in implementing new technologies seeming deigned to improve underwriting (usually by taking credit decisions out of the hands of local bankers), these new innovations merely follow the same flawed underwriting standards; they just deliver the results in a different manner or speed up the process.
And, as we can clearly see, the current methods of underwriting are truly flawed; not just from the current shoddy or non-existent bank lending but also from the very short-term, low impact government run programs like SBA guaranteed loans have on overall small business lending; which on the surface are great programs but are flawed as they too rely on the same underwriting abilities of banks and other financial lenders.
But, leave it to the entrepreneurial determination of many new entrants into the small business loan industry in seeking new ways not just to improve business loan underwriting but to disrupt the entire way that lending is conducted in this country.
For example, most traditional banks loans are considered fire and forget (or more like fire and hope). When a loan is approved and funded, lenders set payment dates (usually at monthly intervals) then essentially take themselves out of the picture (even though they may still require the business to report its financial position periodically).
Then, should a borrower get into trouble, most lenders do not realize it until it is far too late for anything to be done (on both the bank’s and the borrower’s part) – all of which adds risk.
However, there are new entrants that are attempting to reduce some of the risks to both themselves and their customers by not focusing so much on past performance but by looking more at today’s and each day’s cash balance. Thus, instead of collecting payments monthly based on the borrower’s past profitability, they essentially take daily micro payments – payments that seem to place less of a cash flow burden on the borrower as well as reduce some risk associated with longer payment terms. Moreover, by focusing on micro payments, profitability is no longer an underwriting requirement as the focus shifts to daily cash flow (which many businesses can generate even though they have yet to turn a profit).
Further, this type of loan repayment also creates a strong relationship between borrower and lender as the lender works with and evaluates the borrower daily and not just quarterly when financial statements are due.
There are also new entrants that facilitate lending among peers – termed, social lending, that is more community based lending than anything. Based in part off the old and forgotten credo of credit unions where the community supported each other by pooling excess cash from some members and lending it others in need. The real key here is that loan decisions are not based on some far away executed formula but by actual communication between borrower and lenders.
There are also new entrants that look at lending as more of an investment in companies than actual loans – thus they do not require elements like time in business, profitability or collateral. They are more interested in accessing the business’s ability to generate cash flow from the loan proceeds. Not only are there non-bank lenders applying these new techniques but many private equity companies are entering this arena. However, these players are taking it even one step further by approving entire loan requests, but tranching the funds at intervals that are conducive with business growth and development – called milestones.
This type of thinking has also benefited Micro Lenders, who have some of the lowest levels of default in the industry. While Micro Lenders may be able to lend much more than they do on average, there success stems from helping business owners build solid track records while providing them needed capital. Many Micro Lenders usually only approve amounts smaller than those requested in the beginning. But, as the borrower moves forward demonstrating their ability to service that loan amount, the Micro Lender then encourages the business to come back for more capital at larger amounts (even if the original loan is not yet paid off) – it is essentially similar to teaching a infant how to walk by making them craw first.
Lastly, there is the community bank model. While much of the community bank’s underwriting is based on current practices, community banks are the only real shinning example of traditional lending still working. The reason is that these organizations underwrite requests not only by solid lending standards but also via relationships – relationships with the borrower, with the community or neighborhood, with the local business climate as well as with local knowledge of assets used as security. Thus, allowing these lenders to approve loans to businesses that other regional or national banks would run away from.
While many of these new business loan models are still relatively young and have not yet strayed very far from traditional underwriting methods, they are making improvement in the industry; an industry that may take centuries to evolve. But, one never knows how quickly new, disruptive, entrepreneurial companies can impose changes on industry participations that are blinded by the status quo.
However, in the mean time, there still remains hope for small companies seeking business loans to start, manage or grow their enterprises via these up and coming entrepreneurial organization who are seeking new and improved ways to solve the current access to credit issues that nearly every small business faces today.
Joseph Lizio holds a MBA in Finance and Entrepreneurship, is the founder of Business Money Today, has a strong commercial lending background and is regarded as an expert in business and finance.