What’s the future of small business credit?

Posted by: John Tozzi on June 19, 2009

What’s the future of small business credit?

We’ve been writing and thinking a lot about this lately. It’s a peculiar time: We’re in the middle of a recession that was incubated by several years of too-easy credit. When loose lending caught up with banks and other finance companies, they pulled back sharply, and continue to raise credit standards for business borrowers. At the same time, regulators are beginning to get serious about stopping abuses in the credit card industry, though the reforms leave out small businesses.

This morning I read Steve King’s latest installment (PDF) of the Intuit Future of Small Business report, focusing on small business credit. Here are a couple of the trends he points out:

1) Shift toward smaller institutions. Community banks and credit unions are among the most ready lenders right now, because they avoided the riskier securities that blew up the big banks’ balance sheets.

2) Unsecured credit is disappearing. Business owners often use consumer credit – their own credit cards or home equity loans – to finance their companies, but those sources of credit not secured by business assets are drying up.

That second trend is worrying, because small business’s credit needs are changing. More and more companies sell services rather than products, and business takes place online. It takes less money than ever to start these types of ventures, but their costs aren’t things that banks are used to financing. I think of it like this: Secured bank loans are Business Credit 1.0. What’s the 2.0? Instead of vehicle or equipment loans, these entrepreneurs need to pay Web developers and buy server space. Instead of inventory financing, they need to buy Google ads on search keywords. That often means they need less money than companies making widgets, but they don’t have hard assets to use as collateral. Try explaining to your banker that you need a line of credit to buy $20,000 worth of paid search ads each month.

That explains why credit cards, an easy source of unsecured debt, became so popular. But credit cards aren’t stable financing. (The NY Times has a good story this morning about what happens to small business owners when their credit card companies reduce their limits.) Most business owners I speak to who borrow on credit cards say they wish they had better alternatives.

It seems like there’s a clear market need for new types of small business financing. So let’s start a discussion. What does the future of small business financing look like?

Here are some ideas to get started:

Kiva and other peer-to-peer lenders. The industry has run into problems with regulators and higher-than-expected charge-offs. But Kiva’s success overseas shows the model’s potential, and the company just began funding US entrepreneurs.

Community development lenders. Focused on lending in communities poorly served by banks, CDFIs are mostly nonprofits and don’t require the same level of returns that commercial banks do. Could the CDFI model be broadened to become a mainstream source of credit for businesses in all communities?

Crowdfunding. Not too far from peer-to-peer lending, but in this case business’s customers are also financiers. An unproven idea to be sure, but it could work for the right type of venture.

What other creative sources of credit are entrepreneurs using? Which ones can scale? What does Small Business Credit 2.0 look like? Tell us in comments or on Twitter.

Reader Comments

Eric Thomson

June 21, 2009 09:56 AM

Another alternative small business funding instrument you need to watch is the Merchant Advance. These are small business advances ($25-50,000) secured by a claim on future credit receivables. The advance is repaid dialy out of a small deduction from card transaction settlement - typically over a six month period. Over 75% of such advances are renewed.

William Garland

June 23, 2009 10:37 PM

More and more small business owners are utilizing alternative funding sources provided by the SBA. The SBA has gotten aggressive lately to provide solutions to assist these struggling business'. Look into the new ARC loan that is currently being offered up to $35k with deferred payments for 12 months. The SBA will pay the interest on the loan for the first year. After that, your loan is termed out for 5 years. This would be a great opportunity to consolidate some of the credit card debit that you have advanced off of to start or maintain your business.

John McGee

June 26, 2009 01:25 PM

After being in the equipment finance and leasing business for 30+ years I feel an alternative to traditional funding via " Small Ticket " investment banking sourcing private capital can fill needs not being covered by traditional banks that are continually restricted by governmental regulations.
These financing units could provide funding to small business and a decent return to investors.

Blake Robbins

June 29, 2009 07:06 PM

Good article. Especially recognizing and categorizing the different and ever changes industry of business.

As the quote says, "If you focus on results, you will never change - if you focus on change, you will get results."

Business is always changing. If you dont change you will fail. I know there is alot more to it than that, but banks and lending institutions are not exempt from this truth.

Explaining to your banker that you need internet ads (that have mathmatical conversion rates) doesnt always compute to their structured policies.

This is a very necessary time to see change within the conventional funding arena.

Your best days are ahead,
Blake Robbins
www.empoweryourbest.com

http://www.unsecuredbizloan.com/

July 21, 2009 11:41 AM

Being organized and prepared helps alot when applying for a business loan. You should have all your documents ready and be confident.

Iris Carter

August 9, 2009 07:37 PM

With all of the options mentioned, a business owner still needs above 680 personal credit. The SBA, Merchant funding, community banks, etc. they all need to see at least a 680 credit score. Creditors have yet to use new ways to review business credit. Visit www.corporatefasttrack.com/newways.htm

Richard Eitelberg

August 18, 2009 03:44 PM

With respect to the future of small business credit,the two types of institutions you reference,community banks and credit unions: Both have a restricted zone box within which they can make loans. If a business has extenuating circumstances, these lenders generally are not in a position to help.

Meanwhile, unsecured credit isn't disappearing. It has been gone for sometime! The volume of unsecured credit which you describe in this article represents a period of freak excess that has occurred in our economy in one form or another perhaps, once every 25-50 years.

Yes, there is an increase in service businesses that generally do not offer hard goods and materials as collateral. However, some lenders are willing to finance "intellectual property" and place an appriased value on it. There will always be hard goods, and inventory being manufactured by many businesses, which can provide valued assets on which a loan can be made.

"Purchase order financing" and "letters of credit" offers one option of navigating unsecured credit. My firm is willing to look past distress on a small business whether it is: low credit scores, tax liens, debt, and the like. We are able to do this by strictly financing the transaction itself, the merchandise and hard goods, from the period at which it gets manufactured to the point at which it gets delivered to its destination. (We do not finance cash flow, payroll, working capital projects, etc.) "PF" and "LC" enable a small business to do profitable deals without tying up cash and capital.

Richard Eitelberg, CPA
Hartsko.com


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What's it like to run your own company today? Entrepreneurs face multiple hurdles new and old, from raising capital and managing employees to keeping up with technology and competing in a global marketplace. In this blog, the Small Business channel's John Tozzi and Nick Leiber discuss the news, trends, and ideas that matter to small business owners. Follow them on Twitter @newentrepreneur.

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