Entrepreneurial Ways To New Small Business Lending
by Business Money Today - February 8, 2010
Access to capital for small businesses still remains as dry as James Bond's 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 facilities 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 commercial loans are barely 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 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 these 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, or so they say. But, may be this greater risk is more tied 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 be 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 decision 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.
And, as we can clearly see, these current methods of underwriting are truly flawed; not just from shoddy or non-existent bank lending but also from very low impact government run programs like SBA guaranteed loans; 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 commercial lending industry to seek ways not just to improve commercial 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 financials 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. Thus, the underwriting system creates additional 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 financials are due.
Article Continues Below:
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 supports 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 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.
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. 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, 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 entrepreneurial lending models are still relatively young and have not yet strayed very far from standard methods, they are making improvement in this 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; participants that may realize that it is too late for them to change - just look at Sears of the 1960s with their credit card innovations that was easily supplanted by upstarts like Visa and MasterCard who just simply found a better way.
The one thing this last recession really taught us is that something needs to change and if banks and other traditional lenders are unwilling to make these necessary changes, then the industry will change out from under them.
Copyright 2007 - 2010 - Business Money Today - All rights reserved
Small Business Financing Resources
BusinessMoneyToday.com is not liable for your financial actions.
Lenders will, typically at their discretion, perform credit checks with the three major credit bureaus: Trans Union, Equifax, and/or Experian.
Business Money Today or its subsidaries does not fund loans or make credit decisions. Business Money Today is not a lenders or loan broker in any matter and does not charge for any service or product. Further, Business Money Today does not make any product or service offerings and does not constitute an offer or solicit to lend through this website.
The site will submit information provided by you to lenders and other financial service providers. Nothing on this website guarantees that you will be approved for any product listed or advertised. This service is only available in the United States; although all products may not be available in certain states, and may be changed at any time without notice.
Should you have questions or concerns regarding your applications or facilities, please contact your lender or service provider directly.
Any cash advance, factoring or similar product applied for are meant to provide short-term financing only and should not be considered a long-term solution.
Entrepreneurial Ways To New Small Business Lending - Business Money Today