The State of Small Business Financing

Date: November 15, 2013

Small Business Lending Improves

This summer, small business owner Melinda West closed on a $160,000 loan to expand and improve her online retail store’s warehouse space. The loan—at 4.25 percent interest over 20 years—came from a community lender where she’s banked for seven years.

“The bank was super welcoming,” says West, president of SwagsGalore, which sells curtains and window treatments out of Lakeville, Pa. “I didn’t even need to leave my office [for the process].”

It was a different story from four years ago, when West built the warehouse’s first extension using her own savings because the business couldn’t get a bank loan. 

Indeed, the past few years haven’t been rosy for small businesses seeking loans. Although frozen credit markets have thawed a little, not all bankers are rolling out the welcome mat for small businesses due to continuing economic uncertainty. While lenders are giving more, they’re generally focusing on larger loans—$1 million or more—for businesses with the healthiest balance sheets. At the same time, owners who can’t obtain loans, or are hesitant to take on debt amid sluggish sales, are finding alternative ways to finance their businesses.

MyBusiness canvassed financial experts and small business owners to paint the current picture of small business financing.

Small Business Lending Improves

The good news is the financing landscape is improving. In 2011, only 29 percent of small business owners reported having a small business loan (down from 44 percent in 2008), according to NFIB data. Today, the percentage of regular borrowers has rebounded to the low 30s, says Holly Wade, senior policy analyst at NFIB.

In another sign of progress, the Thomson Reuters/PayNet Small Business Lending Index, which tracks loan volume to small U.S. companies, finally reached pre-recession levels for the first time in July. “It looks like we’re seeing a pickup in small business lending,” says Jeff Stibel, CEO of D&B Credibility Corp., which provides credit scoring to businesses.

Big banks in particular are stepping up their lending. The Small Business Lending Index, conducted by New York City-based online loan broker Biz2Credit, found that small business loan approvals by big banks reached 17.4 percent in July 2013, up from 11.3 percent in July 2012. Small banks approved 49.4 percent of small business loans in July 2013, up 2 percentage points since June 2012.

“Now is a good time to borrow,” says Mark Faust, a Cincinnati-based growth consultant and author of the book Growth or Bust! Proven Turnaround Strategies to Grow Your Business. “It doesn’t take rocket science to predict that interest rates are going to go up.” Indeed, interest rates have been at historic lows for the past couple of years but are starting to pick back up. A U.S. Treasury 10-year note neared 3 percent interest in the early fall, while it remained under 2 percent for most of 2012 and 2013.

How Much Debt Should You Take On?

With interest rates low, many businesses are eager to lock in a loan. “Even though interest rates have gone up, they’re still at historic lows,” says Michael Eisenberg, a CPA in Los Angeles.

However, it’s important to consider your individual circumstances before borrowing. These five questions can help you determine if your business is in a good position to borrow—and how much debt you can handle.

1. How much cash will be available to make monthly payments? Bankers will typically look at your business’ debt-to-income ratio and cash flow when evaluating a loan application. “Look at what income is coming in and what fixed expenses you have,” Eisenberg advises. A CPA can help you analyze your profit and loss statement and balance sheet to help you figure out how much debt your business can realistically handle, even if there are bumps in the road.

2. Are there weaknesses to address? A lack of sufficient revenue to cover your expenses will leave you in a weaker position to handle loan payments. Before borrowing to cover funding gaps, Eisenberg advises working with your CPA to find ways you can fix the problem. “Can you raise the cost of the product you’re selling to raise some additional revenue, or can you review your overhead expenses to see if there’s any place to cut expenses?” he asks.

3. Will a loan ultimately increase your cash flow? If you are taking on a loan to pursue a new line of revenue, then borrowing can be a smart move, says Eisenberg. But there is a caveat: Your plan needs to have a very realistic chance of success, or you could end up with an unmanageable amount of debt.

4. Are you paying too much interest on another loan? Getting a loan at a better rate so you can pay back another high-interest loan may leave your business in better shape financially, Eisenberg says. Lower monthly payments can free up cash for other uses.

5. What will happen if your business can’t pay the loan? Financial information company Sageworks found in early 2013 that the average private company’s probability of default was 3 percent, down from almost 5 percent a year earlier. However, some industries are healthier than others, so if sales are slowing—and you’re thinking of personally guaranteeing a loan—it’s important to consider what resources you will be able to tap if your business can’t pay it off.

Businesses Seeking Larger Loans Are Successful

Despite signs of slight improvement in lending, challenges remain for owners seeking loans.

By many accounts, it’s still very hard for those with less than stellar balance sheets to get bank loans. In the third quarter of 2008, when small business lending was at its peak, 41 percent of respondents to the Wells Fargo/Gallup Small Business Index said obtaining credit was easy over the past 12 months. In the Q3 2013 edition of the survey, only 22 percent said it was easy to obtain credit. Additionally, the Federal Reserve Bank of New York found in a May 2013 study that while 55 percent of profitable businesses in New York, New Jersey and Connecticut got their loans approved by banks, just 26 percent of those operating at a loss and 19 percent of those at break-even did. 

“All financial people look at your credit history,” notes CPA Richard Levychin, a partner in accounting firm KBL LLP in New York City. Often, those with troubled balance sheets need to turn to higher-interest alternative lenders for short-term financing, unless they can clean up their credit scores, he notes. 

Many are doing just that: The Thomson Reuters/PayNet Small Business Delinquency Index, which measures payments that are 31 to 180 days past due, reached an all-time low of 1.48 percent of loans in July, down from a high during the recession of 4.73 percent in mid-2009. Still, banks’ cautious behavior will likely continue for at least the next few years as the memory of the financial crisis lingers.

Businesses seeking larger loans seem to have an advantage over those seeking what are considered microloans. Amid continuing economic uncertainty, many banks are focusing on larger deals—of $1 million or more—in which they can make the most money.

According to a U.S. Small Business Administration Office of Advocacy report, the total value of loans of more than $1 million rose 12 percent from 2011 to 2012. In the same period, the total value of outstanding loans of $100,000 or less decreased about 1 percent. Loans up to $1 million faced a 3.1 percent decline.

But that doesn’t mean it’s easy for owners to secure a large loan. After her longtime banker retired, NFIB member JoAnn LaGuardia spent two years finding a new lender that was willing to pony up the money to refinance her 44,000-square-foot building for the two businesses she runs in Youngstown, Ohio, with her husband, William. One of their companies, LM Engineering Inc., makes custom shipping cases for transporting delicate electronic equipment. Their second company, Precision Foam Manufacturing, fabricates foam for the interiors of those cases and other packaging items. The two businesses generate combined revenues of less than $3 million and have been profitable most years, LaGuardia says. 

“I can’t tell you how many banks I met with,” she says. “KeyBank was the only bank that entertained my offer and worked with us.” The LaGuardias ended up with a 25-year SBA-backed loan from KeyBank in November 2011 at about a 5 percent interest rate. 

Bank Loan Alternatives

Not all small business owners are eager to pursue bank loans. Fortunately, there are other financing options for businesses. 

Online crowdfunding platforms like Kickstarter and Indiegogo, a method of acquiring small loans from several independent investors, have also steadily gained ground as an alternative to borrowing from banks. The amount of money secured through these online hubs nearly doubled from $1.5 billion in 2011 to $2.7 billion in 2012, and should rise to $5.1 billion globally this year, according to research firm Massolution. Peer-to-peer lending, considered a form of crowdfunding, has also been growing. Massolution found it grew to $1.2 billion globally in 2012, up 111 percent from the year before. (Peer lending is a transaction between people, not businesses.)

Some entrepreneurs have plunged into raising equity investments from high-net-worth accredited investors on crowdfunding platforms, a process now allowed under the JOBS Act. This has been a particular boon to early-stage startups being bypassed by venture capitalists, according to some observers. Funding from venture capitalists has picked up, however. According to the National Venture Capital Association, total venture capital funding for early-stage startups was $13.4 billion in 2010; in the second quarter of 2013, funding of early-stage startups was already hovering near $3 billion.

Such activity is likely to pick up steam following a July 2013 decision by the Securities and Exchange Commission to lift a general ban on soliciting accredited equity investors through social media sites and other venues. (A date had not been set as of press time for putting the decision into action.) Meanwhile, entrepreneurs have been waiting for an SEC decision on whether they can sell equity to the general public, which some observers worry could expose unsophisticated investors to fraud. 

Crowdfunding isn’t likely to eclipse bank loans any time soon. Most businesses need a steadier source of financing than it can provide, notes Rohit Arora, CEO of Biz2Credit. That may change if more institutional investors get involved in crowdfunding in the future, as he expects. “At the end of the day,” he says, “it has to be more stable and predictable.”

In the meantime, crowdfunding is providing real-world results for some small businesses. In July, Jeanne DeSanctis and her sister Laura Dugan turned to Indiegogo to help finance their invention, the ChargerGenie, a tote bag with a power strip inside that can charge up to eight devices. The sisters exceeded their $45,000 fundraising goal two days before the deadline, which was two months after the campaign launched. To make sure the campaign succeeded, DeSanctis and Dugan hired a professional publicist who reached out to traditional media outlets, bloggers and popular social media users to secure reviews of the bags. “We needed almost every day of the campaign to reach our goal,” DeSanctis says.

Why You Should Consider Smaller Banks

For now, it appears that most small businesses will continue to work with banks. And there is at least anecdotal evidence that more entrepreneurs are turning to smaller banks for their needs. When NFIB member Kimberly Sparks, chief administrative officer at Madaket Marine in Nantucket, Mass., sought a $400,000 line of credit to pay for a new forklift and septic system in 2011, she turned to the big bank that had long served her company.

Her company, which she says generates up to $5 million in annual revenue with 12 year-round employees, received the loan at a 5.25 percent interest rate and paid the debt off in 2013.

However, she was never happy with the big bank’s customer service. After a frustrating experience trying to get help in buying Treasury bills for the company—and having a bank employee refer her to the bank’s website to fend for herself—Sparks changed to a community bank, Cape Cod 5, where she found branch employees more helpful. She recently moved $700,000 to the institution. “We are perfectly comfortable that they will extend credit to us, should we need it,” she says.

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