What can you do as a small business owner or entrepreneur to get the financing you need? There’s more than one way to finance small businesses, and we’ll explain how shortly.
If you haven’t been fortunate to secure a small business loan or credit line from the larger financial institutions, don’t expect the odds to be in your favor. Bad news? Yes, I know,… but take heart.
The Basel III guidelines, intended to prevent further financial crisis, will require lenders such as Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM), and Wells Fargo (WFC) to substantially increase the capital they hold against risk-bearing assets—up to five times what they are required to maintain today. So to prepare for the future, those policies will start to go into effect in 2013. All the larger financing banks are making changes to lending practices. In effect, when a small businesses line of credit reaches maturity, it’s the end of the road for borrowing for that small business.
So to give you an idea of available alternatives, here’s the top three:
1. Small Business Administration-Certified Non-bank Lenders. (For US Only) There are only 14 lenders who exist, and they have a grandfathered status from the SBA. This means that the SBA oversees them instead of state and federal bank regulators. The good news about this is that this enables these lenders to take on loans that their competitors can’t. These lenders focus on the SBA’s 7(a) and 504 guaranteed loans, which top out at $5 million. The lender’s underwriters target specific regions and industries which gives them much greater flexibility and creativity. This is much better than a run of the mill underwriter at a big bank ruling out businesses that are struggling as “undesirable” , all because he doesn’t understand the business and doesn’t know how to spot a sound investment.
To locate an SBA-certified non-bank lender in your area, visit the SBA’s website or contact your SBA district office and ask for a list of active lenders.
2. Community Banks and Regional Lenders. The factors that give non-financial lenders an edge also apply to SBA-certified small and midsized lenders with less than $2 billion in deposits, which are also exempt from many of the capital requirements imposed by financial regulatory reform. A focus on local banking breeds industry- and geographic-specific expertise, which helps community banks avoid a cookie-cutter approach to analyzing creditworthiness. If your business is creditworthy, this is good for you.
SBA-guaranteed lending is also the focus of most community banking activity. Although the SBA sets specific guidelines for the type of applicants it deems creditworthy (including personal credit score, business profitability, and collateral requirements) and provides a 90 percent backstop, banks remain on the hook for the entire loan in the event that a default arises in the first 18 months. The downside of early default can be significant, so risk acceptance continues to vary from SBA lender to SBA lender.
Businesses in such hard-hit industries as restaurants or retail will have an easier time convincing a banker who has previously executed similar loans that they can pay back. The same applies for companies located in struggling regions with high unemployment or above-average foreclosure rates. Smaller lenders often specialize and can look past a national underwriting mandate to evaluate creditworthiness on a case-by-case basis, factoring in an owner’s reputation within the local community.
To locate a SBA-certified community or regional bank in your area, visit the SBA’s website or contact your SBA district office and ask for a list of active lenders.
3. Community Development Financial Institutions. There are over 1,000 registered CDFIs in the U.S., according to trade group Coalition of Community Development Financial Institutions. CDFIs can provide access to more substantive capital than the few-thousand-dollar microloans that most entrepreneurs associate with them. “The alternative-finance sector exists because there is a gap in the conventional market,” says Edwin Hong, interim president of New York City-based CDFI Seedco Financial, who says Seedco’s loans range from $50,000 to $750,000 for up to five years.
Most CDFIs require a business to have been operational for at least a year, with most successful applicants having been in business for three years to five years. You should know that all CDFIs require rigorous documentation and most have a regional focus. Unlike traditional banks, however, they are willing to work with you to gather and assemble clear financial statements as needed. Because of how they work, the process can be slower and capital can cost more. If you can get a loan elsewhere, you should. But CDFIs offer a good resource to those that traditional banks will not consider, including entrepreneurs with credit scores in the low 600s.
To find a CDFI near you, use Opportunity Finance Network’s locator tool.