It would be an understatement to say small business lending has taken a significant blow over the past few years. The rocky economic climate of the recession all but froze access to credit for entrepreneurs. According to a 2011 SBA report, the total value of small business loans in 2010 was around $652 billion—a staggering drop from $712 billion in 2008.
The good news: Recently, government initiatives, such as the Small Business Jobs Act, have bolstered small businesses and freed up lending lines—and the proof is in the numbers. In Capital One Bank’s 2011 survey, 85% of U.S. small business owners said they were able to get the financing they needed.
But experts are still cautious.
“The level of risk aversion is still extraordinarily high,” says Barry Sloane, CEO and President of The Small Business Authority. The primary concern is one word: collateral.
“It’s almost like a bi-polar world,” says Ami Kassar, CEO and Founder of the business loan advisory company Multifunding. “If you’ve got a strong small business and a lot of collateral, banks are going to fight to get you a loan.”
But if you don’t, like many small business owners whose collateral comes from the equity in their houses and commercial real estate, you’re looking through a narrower, albeit still viable, scope of lending possibilities.
“The recession has decimated so much of that collateral that now most small businesses have to go out and seek alternative financing because traditional or SBA loans aren’t an option for them,” says Kassar.
Here, a few experts weigh in on how to navigate this new loan landscape.
New Rules of Getting a Small Business Loan: Factoring
In factoring, businesses sell their invoices at a discounted rate to a third party or “factor.” The business gets immediate cash flow and the factor assumes all liability of the debtor.
Unlike a loan, factoring focuses not on the creditworthiness of the small business owner, but that of the debtor and also the value of the invoices.
“This way you don’t have to commit to some 3-year line of credit with big fees where every time you sneeze they’re charging you,” says Charles H. Green, Executive Director of the Small Business Finance Institute.
Keep in mind, however, factoring isn’t the wisest choice for all small businesses, says Kassar. Be sure to assess the whole picture: Will the factor charge a service fee and/or interest? Or will the rate of return from selling discounted invoices be worth it in the long run?
New Rules of Getting a Small Business Loan: Private Lenders
If you have sufficient collateral tied to real estate and want to avoid the rigid credit policies often associated with bank loans, going through a private moneylender may be your best bet, Kassar suggests.
Dig Deeper: What Loan Officers Really Want
You can find private investors directly or, better yet, through a loan officer who would serve as the middleman. Since they aren’t “packaged deals” like bank loans, it’s important to note that the terms of a private loan will vary case to case depending on what your loan officer has available.
Before settling on this method of financing, Kassar warns that private loans bear high interest rates and are riddled with additional costs, such as document preparation and referral fees.
New Rules of Getting a Small Business Loan: Small Business Administration (SBA)
“The SBA is the best source for long term capital financing for a small business,” says Green—namely, the 7(a) loan program.
With the Small Business Jobs Act upping the guaranty against default to 90% and also raising the maximum loan amount to $5 million, the 7(a) loan was revamped to make banks want to lend to small businesses and to entice small business owners to actually apply for the loan.
New Rules of Getting a Small Business Loan: Small banks
The other popular route for acquiring a small business loan is to go directly through a bank—and in this case, size does matter.
Dig Deeper: How to Fill Out a Loan Application
When shopping around for a bank loan, think “small with a capital S,” Kassar advises. “You’ve got to find an entrepreneur-friendly local or regional bank in your community that’s going to be more flexible,” he adds.
While larger banks are better at delivering “cookie-cutter” financing options, smaller banks offer entrepreneurs more of a personal, hands-on experience. No matter which bank you decide on, however, be very cautious of spin. “Oftentimes the bank will nurse your story along for several weeks before they finally turn you down,” says Green. “What they’re not telling you is that they knew the day you walked in there they’re not making the loan because they don’t have the capital.”
Check the bank’s Texas ratio—a formula that measures the health of a bank based on its credit troubles. “If a bank has a score of more than 150%, they might already be suspending most lending activities,” notes Green. “Also check FDIC.gov to determine if a bank is under any kind of consent order, which may indicate extra regulatory supervision and financial weakness.”
New Rules of Getting a Small Business Loan: Do you really need it?
“One of the best financing techniques is to not need money,” says Green. A seemingly obvious statement, yes, but many entrepreneurs are too quick to seek out a loan before taking into account what they already have, i.e. bootstrapping.
Think creating a home office instead of renting a space, or outsourcing projects or hiring freelancers instead full-time employees. Both are simple ways to reduce the amount of outside funding you’d need to start or grow your business.
“The first thing you should do is look at your own resources,” says Sloane. “If you have X amount in savings and you wanted to start up a business, ask yourself if you can afford to lose it all. This way you’re taking a risk on your own business and you don’t have to pay back principal or interest.”