The state of small business financing has been a mixed bag lately, as Joel Libava previously wrote about on Small Business Trends. But slowly, things seem to be improving. Last month, The New York Times reported that more small businesses are seeking—and getting—bank loans. And in a new study by Capitol One, 85 percent of U.S. small businesses surveyed say they are able to access the financing they need—up from 70 percent at the same time last year.
But what kind of capital are these businesses getting, and is it helping—or hurting—them in the long run? A new survey by MultiFunding LLC, a firm that helps small companies find financing, sheds a slightly different perspective than most surveys on the issue.
MultiFunding’s National Small Business Lending Snapshot focused on small and relatively new businesses: The companies surveyed had average annual revenues of $750,000 and had been in business an average of only three years. Culled from a wide variety of industries and regions, the entrepreneurs in the survey were MultiFunding clients actively seeking an average of $325,000 in loans; more than 25 percent had already been rejected by banks. The study sought to determine what loan types small business owners in today’s market can qualify for and what interest rates they can expect to pay for their loans.
MultiFunding found that banks classify loan applicants into one of three categories and base their approvals and interest rates on the categorization. Here’s how it breaks down:
1. Asset-Rich Business Owners – (31 percent in the study)
These business owners have assets and/or the cash sufficient to meet the collateral requirements of banks and SBA lenders. As a result, they’re able to obtain interest rates between 3 percent and 8 percent a year. “Government supported SBA programs favor this group,” the study says.
2. Marginal Business Owners (47 percent in the study)
These business owners have credit and cash flow, but lack the assets to serve as collateral. Considered “B-level” borrowers, they have to use less desirable and more costly financing methods, including factoring, merchant cash advance loans, unsecured loans and private money loans. “They pay a high premium because of their lack of collateral,” the survey authors say.
3. Non-Lendable Business Owners (15 percent in the study)
A triple whammy of bad credit, poor cash flow and lack of collateral leave these small companies ineligible for financing at any price.
Even for small businesses that can get financing, the interest rates are often prohibitive to continued growth. Just 10 percent of entrepreneurs surveyed qualified for conventional loans from FDIC-insured banks. MultiFunding found that approximately 40 percent of entrepreneurs would have to pay more than 23 percent in annual interest and charges if they were able to get financing, and 21 percent of owners would pay more than 30 percent. Those rates are comparable to those of credit card financing, which most small business experts typically caution against.
Based on these lending trends, MultiFunding concludes, “Small businesses are facing a national lending crisis that is not adequately reflected in the data published by the nation’s leading lenders.” The situation is particularly challenging for small businesses with income under $1 million per year as these interest rates pose a problem with staying in business.
“In today’s economy, collateral is a key factor in determining interest rates,” the report continues. “Credit and cash flow, previously important in assessing a small businesses’ credibility, have taken a backseat to equity in their balance sheet.”
Have you had trouble accessing credit at acceptable interest rates?
It seems this study is saying lending standards have returned to what they were pre-credit bubble. By that I mean the mid 90s, before debt securitization made credit easy to get for both consumers and small businesses.
The interesting question is what level of credit availability is optimal for the economy? I think it’s safe to say the very loose credit standards that existed from the late 90’s to 2007 didn’t turn out so well.
That makes for a tough situation, but companies that do succeed in this environment will be strong and financially fit companies that should do a lot of good when the economy starts to pick up.
Thanks for your usual data-packed insights. You rock!
The scary part for me (in the report) was this;
“Culled from a wide variety of industries and regions, the entrepreneurs in the survey were MultiFunding clients actively seeking an average of $325,000 in loans; more than 25 percent had already been rejected by banks.”
25%% were previous turn-downs?
What is the deal?
Without serious collateral, it isn’t looking to good. I wonder how the start-ups are faring?
The Franchise King®
Thanks Joel. While it has always been tough for startups to get funding, it does seem particularly hard these days. Creative thinking is called for. Or a rich uncle 🙂
I think the real issue here is that small business owners have lived in a world too long where underwriting guidelines were unrealistic and lose. This of course breeding business owners with sloppy bookkeeping practices and a perception that I can get a lot with a little.
Business owners don’t know the first thing about applying for business financing. They don’t even know their business has a credit score. They know how to run their little restaurant or towing business but they don’t understand finance. They are uneducated and ill-equipped to make good decisions or to prepare themselves for good quality business financing.
Because of this issue of business owners not having the proper education they walk into a bank or lender asking for unrealistic dollars based on what they have as a business today, hurting themselves in the long run. Hurting their personal credit score, their business credit score and any luck to be approved for business financing 6 months down the road.
As collateral is important to any business financing transaction, the simple lack of education is what is truly killing these business owners. They may have collateral and decent cash flow but lack the skills to understand that asking for $200,000 from a bank that doesn’t know you is a business financing 101 no no.
We need to educate these business owners on how to take the proper steps to seek financing so they are approved the first time building a strong corporate credit asset for themselves and their business.
Tray you said it best most small business owners put in excess hours and consultants are mega dollars ?????????????????????
Trey makes a spot-on point above about business owners educating themselves before they sit down with their local banker and ask for a loan.
Just as a business owner can hire an attorney to represent them and an accountant to keep the books straight, he or she can hire financial muscle with a part time CFO. You only pay for what you need, and the ROI is immediate and extraordinary.
Thanks for your insight Trey. Funding remains quite difficult for many business owners.
While I certainly agree many business owners may not be properly educated on how to best seek financing. I don’t think the banks help educate small business owners. Banks often don’t like the smaller business loans. In the article $375k average loan amount. The cost to underwrite, process and service these loans (when combined with defaults) at lower interest rates, are a losing proposition for the banks.
Steve’s question of “what level of credit availability is optimal for the economy?” is very interesting. Credit has always seem to work on a pendulum swinging hard one way when credit windows are wide open and then coming violently back in the other direction. What about business lending from other countries – are their other countries that “do it right”?? Are their loan products and securitization methodologies that seem to offer steady flows of funding while simultaneously not getting greedy and making the credit windows fly open to meet supply and demand needs?
Small business loan climate will improve very slowly. http://reut.rs/jlQBp4
Find out here why and how to find a locally owned bank who is much more likely to treat you and your business properly and personally.
Your article was a great insight. I help provide workng capital to business through merchant cash advance. I think if you look at the mca through different angles it will benefit any company who has the positive cash flow and healthy business,but need capital to grow there business.If a business owner will use the funds to get a decent return on there capital this will lower the cost of capital. Since we purchase there future credit cards receivables in exchange for money today the money must be discounted,because money today is worth more than money in the future. So when someone say mca is expensive capital They might not know how to turn $1 in to $100 . The Business owners who know how to get A decent return are the ones who will benefit from a merchant cash advance!
I hear you Mary….. turning $1.00 into $100.00 – WOW…. I deal with business owners everyday and the ones that can turn 1.00 into 100.00 seem to be fewer and further between. The ones that can do that certainly think MCA’s would be “cheap” access to capital. For a business owner to borrow $50k now, in exchange for say $65k or 69k in future credit card receivables (in 6 or 7 months) is expensive money – I really don’t care how much lipstick you put on it…. that is expensive capital. MCA’s certainly have their place – but business owners need to make sure they understand the true cost. Business owners with sub 600 credit scores may not have a choice other than an MCA. But business owners with a >600 score should check out alternative strategies as less expensive alternatives. Anyone can chime in here but MCA factor rates are typically 1.38 on 6 month (give or take), Ondeck is typically 1.22 on a 6 month (give or take) and IOU Central is 1.21 on a 12 month term (give or take).