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OCTOBER/NOVEMBER, 2007
Hungry for Cash Startup capital grows scarce JC Converse has drawn up plans for a Laguna Niguel (Calif.) restaurant that will be built of recycled materials and serve quail tacos, buffalo meat loaf, and other organic food. Now the 52-year-old needs money. Although Converse, who has spent 35 years working in restaurants or for suppliers, is putting $250,000 of his savings into the venture and has about $200,000 in home equity to use as collateral, four banks have turned down his request for a $550,000 Small Business Administration loan. If the rejections keep coming, says Converse, "I'll have to dust off my résumé and start looking for a job." With lenders spooked by late summer's credit crunch and the housing market continuing its slide, many entrepreneurs, particularly startups, are finding capital harder to come by. Banks have tightened the spigots, and even Small Business Administration 7(a) loans, which often are easier to obtain than other bank loans, may be tougher to land. Declining home values in many parts of the country are limiting the amount of equity that business owners can use as collateral for loans, as well as the amount of credit available to them. The upshot: Entrepreneurs like Converse may be putting their plans on ice. The rate of business creation, which has risen steadily since 2002, with an estimated 650,000 new businesses in 2006 alone, according to the SBA, may well slow. Entrepreneurs "may have less potential to tap startup money through a home equity loan, and banks are more strict in their underwriting requirements for those loans because they may feel worried about other areas of risk on their balance sheet," says Jared Shaw, Northeast banking analyst for Keefe, Bruyette & Woods in Hartford. Although the Federal Reserve's half-point rate cut on Sept. 18 may lead to lower interest rates on debt such as SBA loans and credit cards, that won't happen overnight. And lenders are likely to remain strict until they are sure the economy is on solid ground. "The Fed's reduction won't really change the longer-term trend of credit standards continuing to tighten," says Tom Kersting, equity analyst for Edward D. Jones, the Des Peres (Mo.) retail brokerage. Entrepreneurs with high credit scores, and established companies with good credit histories, should still be able to score loans. Startups in high-tech and other businesses that depend largely on intellectual capital, which are more frequently funded by private equity and venture capital, are less likely to get drawn into the credit quagmire, says David Hsu, an assistant professor of entrepreneurial management and technology strategy at University of Pennsylvania's Wharton School. But, says Hsu, "traditional small businesses, like a laundry or retail store, that take out a loan or tap some home equity will be pretty affected and will be less likely to engage in new ventures." About 30% of small business owners have used either a second mortgage, home equity loan, or line of credit to help finance their business, according to an August survey by Discover Small Business Watch. Robert Fairlie, a professor of economics at the University of California at Santa Cruz, looked at home value data by region and found a 20% increase in entrepreneurial activity for every 10% increase in home value in an area. Says Fairlie: "There is a link between home values and entrepreneurship, and definitely a link between homeownership and entrepreneurship." And because banks and other lenders examine how much equity an applicant has in a home, slipping housing prices affect loan decisions as well. "There is no doubt with falling real estate values that if a deal has some other issues besides a collateral shortfall, that could create a situation where we may not be able to provide financing," says David Bartram, president of the SBA division for US Bank, based in Minneapolis, and chairman of the National Association of Government Guaranteed Lenders. Says Jim Hammersley, director of the office of loan programs for the SBA in Washington: "Some borrowers who may have qualified for 7(a) a year or so ago, and folks at the lower end of the credit spectrum, may have difficulty getting a loan with an SBA guarantee." About 90% of loans approved by Southern California Reinvestment CDFI, a community development organization in Santa Ana that lends to small companies, are backed in part by the borrower's residential real estate. Stacey Sanchez, executive director, says in the past her institution might have approved loans when the borrower's equity was small on the assumption the value of the home would appreciate. It is less likely to do so now. One upside is that the Fed's rate cut will put downward pressure on the prime rate, which in turn affects the interest rates on another common funding source for startups—credit cards. "The cost of that debt will come down," says Scott Valentin, an analyst at Friedman, Billings, Ramsey Group in Arlington, Va. Still, says Valentin, some credit-card issuers are already toughening terms, cutting credit lines for the riskiest existing customers. They also are mailing fewer offers with low teaser rates. According to market research firm Synovate, only 48% of credit-card offers in the first half of 2007 came with a low introductory rate for purchases, compared with 56% in 2006. Some entrepreneurs find that leaner times test their mettle. But that may not be entirely bad. "Firms founded in recessionary times tend to do better in the long run," says Wharton's Hsu. "Entrepreneurs have to be very choosy because they won't have as many surplus resources." And a good business idea will thrive in any climate.  By Amy Barrett and Jeremy Quittner
BW MALL
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