Industry Source Networks Blog

Small businesses have been having difficulty getting approved for lines of credit and other types of loans by large national banks.  Some of these companies have also lost existing lines of credit as companies such as American Express have cut back on their small business programs.  Many small business owners have started to use credit cards, both personal and business, as their short term financing tool.  The problem with this approach is that many credit cards charge as much as 20% interest on the balances on their cards.  Most small businesses can not afford to pay off these balances on a monthly basis so a large amount of their scarce cash goes to interest payments to the large banks who refused them a line of credit in the first place.  So what should a small business owner do?  Well there are banks who are lending to small businesses.  We, Industry Source Networks, have created a network of banks who specialize in providing lines of credit to small businesses.  Many small businesses have gone directly to using credit cards without even applying for a line of credit because they assume that banks are not lending.  If your business is profitable or has recently returned to profitability over the last couple of quarters then you are eligible to apply for a line of credit.  Avoid applying to the large national banks as their underwriting standards have become very inflexible and most small businesses cannot qualify under these standards.  Talk to a smaller bank that has recently made small business loans and find a loan officer who wants to delve into your business and really understand how it works and what your needs are.  Not all small banks are lending so be sure to interview several banks to determine the right fit.

There is a vicious cycle going in small business lending.    It goes something like this:

1. Small business gets battered by the economy.  The business is still profitable but less so than before.
2. The business sees its lending facility pared back or eliminated by their bank.
3. Small business cuts jobs, moves to a smaller building or stops future equipment orders so that their expenses reflect the reality of their new lower revenues.
4. Small business owner takes their austerity program to their lender in hopes of restoring some of their lost borrowing capabilities.  The lender looks at the lower revenues, layoffs and downsizing as a further deterioration of the business.  The lender lowers the business’s line of credit even further.
5. The business now has to run on even less cash and is not able to replenish inventory at the levels needed to grow its business.
6. Go back to step 1 and repeat until the business becomes truly uncreditworthy and eventually becomes insolvent.

So what can be done to break this vicious cycle?  First the Federal government must pass the small business bill which will give $30 billion to community banks to lend to small businesses.  Community banks are primarily focused on lending to small businesses.  Next, underwriters at banks lending to small businesses need to look at their lending criteria.  Credit benchmarks must be adjusted to take into consideration the current status of the economy.  This means that bank underwriters should take a longer view of the performance of the small business.  This should enable the lender to possibly provide a larger credit line than would be warranted by strict adherence to traditional underwriting guidelines.  These additional funds will enable businesses to invest in growing their businesses again and start the process of reversing the cycle and hiring will follow.  The proposed small business legislation makes some guarantees around the funds that the Federal government is providing to community banks so the banks will not be taking the additional risk of lending to small business without the federal government providing a backstop.  While this creates some exposure for taxpayers, I think this is an instance of taxpayers making an investment in their personal financial well being.

The SBA recently issued a report on how small businesses use trade credit.  The report found that  20% of small businesses don’t use trade credit, 20% only use bank credit, 20% use only trade credit and 40% use both bank and trade credit.  The interesting aspect of this study is the impact that the usage of credit had on the growth rates for these companies.  Companies that don’t use either bank or trade credit tend to be smaller companies with higher average profitability.  Companies that use both trade and bank credit tended to be the largest companies but with lower average profitability.  This makes sense because if a company does not take on debt then they also have no monthly debt payments and this will increase their average profitability.  The downside of no debt is that the company does not have the cash to buy the plant, equipment or people necessary to grow their business.  Companies that take on debt are able to buy these assets to grow their business.  They however have to be run in a disciplined manner as they have to make a monthly payment to their financing institution.  So these companies tend to have lower average profit than debt free companies.  Even though debt free companies  have a higher rate of profitability their absolute profit may bay be significantly less than companies with debt because of the scale that companies that take on debt can attain.  Small Business Owners must think through where on this scale they want to be.

The media is full of stories about how difficult it is for small businesses to get a small business loan from a bank or other financial institutions.  These small businesses are typically looking for money to expand or renovate their buildings, buy capital equipment or for working capital.  The reality is that there are a significant amount of money available for small businesses.  So why don’t small businesses get access to the much needed funds to grow their business?  They make the following mistakes:

1. Seek Funding from large banks: Large banks such as Bank of America, Chase or Wells Fargo are not lending to small businesses.  They are trying to recover from the recent financial meltdown by investing their TARP dollars in stock, hedge funds or  other risky assets to get outsized returns.  They are also bracing for financial reform coming from the government by keeping more cash on hand.  The one area they are not embracing is lending to small businesses.
2. Do Not do enough research on regional and  community banks: The small business action right now is with community and regional banks.  These banks specialize in lending to businesses in their geographic region and tend to look beyond just the numbers to understand if a business is credit worthy.  The only tricky issue is that government has been very aggressive about taking over and selling the assets of regional and community banks that were involved in the residential mortgage mess.  So you have to be careful and know your bank before you apply for the loan.
3. Small Business are not prepared for meeting with lenders: Many small business owners and principals are not financial people by training.  Lenders look at the world through the window of financial statements.  Many business owners do not have an understanding of their financial statements when they go to meet with their bankers.  Many companies that would otherwise be eligible for a loan get so intimidated by the questions that they don’t follow-up and turn in an application.  Meet with your accountant or print off your financial statements – last three years income statement and balance sheets at a minimum – before you meet with your banker.  You should also be able to explain any glitches in the financial performance of your business over this time.  If possible you should also have your financial statements updated to within 60 days of the meeting.
4. Small Business owners do not understand basic lending criteria: Small business owners must understand the basic lending criteria used by banks and other financial institutions to make loans.  First most lenders require that an organization have positive cashflow for at least the last two years.  If you have a history of positive cashflow but had one bad year then you can still apply but need to have a good presentation of what happened and why it won’t happen again when you meet your banker.  The best measures of cashflow are your net profits on your income statement and net cashflow on your statement of cashflows.    You may also want create a projected income statement where you plugin the projected mortgage amount into your income statement.  Your income statement should still be positive net profit after your inclusion of the mortgage amount.  You can determine your mortgage amount by using a mortgage calculator such as this.  If you are a start-up business you can still get a loan you will have to create financial projections and convince the lender that you will meet or exceed the projections.
5. Small Business owners don’t submit their loan applications: Many credit worthy organizations go through the trouble of meeting with a lender but never submit their loan applications.  We have met with a number of lenders and the most often cited reasons that small business owners do not submit their loan applications are: disorganized financial information, extreme time pressures and fear.  Fear is the most common reason that the process ends after the first meeting.  This is a shame because this inability to get comfortable with the lending process causes the company to lose access to funds which could be used to get a new building or purchase new capital equipment or replete inventory levels or hire new employees.