Small Business Lending: One Size Does Not Fit All

Speaking to a colleague the other day about the challenges of funding a small business, he suggested that we’re looking at it all wrong. The idea that options available for small business owners come down to choices between traditional financing, alternative financing or venture capital is the wrong way to look at funding small business initiatives. “Even if the business relies exclusively on debt financing to fuel its capital needs, business owners should look at the financing options available to them as a ‘portfolio’ of investment options,” he suggested.

I agree. One size does not fit all — two or three sizes don’t fit all either.

I think we can agree that most of the Main Street businesses we talk about here will fuel growth and fund working capital with borrowed money or cash flow. Fortunately, there are a lot of options available. Unfortunately, many small business owners look at the options as an either/or choice to be made. I think it makes sense to look at financing options that are appropriate to different situations and how they might work together to help small business owners find the capital they need.

For example, I’m convinced that a good relationship with a community banker is very important to the long-term health of a small business. That’s not to say an SBA loan or other traditional loan is the best and only answer to the financing needs of the local dry cleaner or restaurant. Yes, interest rates are lower on a traditional fixed-term loan, but how quickly a small business owner can access capital can be problematic with a term loan that takes weeks or months to fund if the small business owner needs the cash now.

And, the elephant in the room is that many Main Street business owners don’t have the credit, time in business, or revenues to meet traditional loan criteria. This is particularly painful for early or idea-phase startups. No history, no product and no revenues usually mean no loan.

For a business owner who doesn’t match the underwriting requirements of a traditional lender, alternative loan products can help establish credit while allowing the borrower to fill his or her short-term capital needs. Alternative lenders have less stringent lending requirements than does the local bank — but that comes with higher interest rates. Because of higher interest rates, small business owners should look at repayment terms of a few months rather than a couple of years. Although alternative financing can be a powerful tool when used correctly, it can also be very costly if misused.

Many small business owners who do qualify for low-interest term loans still turn to alternative financing methods as a short-term bridge to a traditional term loan while they wait for a traditional loan to be funded. If the business owner is trying to take advantage of an opportunity and can’t wait for an SBA or other traditional loan to close, the additional interest they pay over the two or three months they wait is well worth almost immediate access to capital offered by alternative financing.

When looking at the many financing options available for small business owners, some of the questions that should be asked include:

1. What is the range of terms available?
2. Are there any upfront costs?
3. What is the minimum credit score required to get the loan?
4. What are the underwriting requirements in addition to my credit score?
5. How quickly can the loan be funded?
6. Do I need the cash now, or can I wait?
7. Do I have the ability to make regular and timely payments?

A couple of weeks ago another colleague suggested that a small business owner should treat his or her credit score like a precious asset. Sometimes short-term financial decisions have long-term consequences. I spoke with a business owner a few months ago that had a good business idea but no collateral, no income and no credit. He was frustrated and upset that lenders weren’t interested in his idea and weren’t falling all over themselves to give him money. He wasn’t interested in bootstrapping because it would cause him to scale back his growth plans. It wasn’t what he wanted to hear, but bootstrapping his idea was the only real option available and the approach I suggested. Many incredibly successful companies were started by an entrepreneur who bootstrapped his way to the top.

What’s the best approach for your Main Street business? There are certainly more than one or even a combination of many options—once size does not fit all.