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Where Do Small Businesses Go, When Banks Say “NO”?
On January 31, 2010, the New York Times (pg 1 & 6) featured an article on alternative financing for small businesses. A survey by the Times found that small business owners say that banks are routinely rejecting applications for loans that were readily available only two years ago.
A recent study by the U.S. Treasury Department found a sizeable decrease in lending to small businesses by 22 of the largest bank recipients with federal bailout money. Therefore, small businesses have been forced to resort to factoring or relying on purchase-order financing since lines of credit have diminished at banks. The bank’s underwriters have tightened credit and have essentially shut lending down.
Small businesses find that factoring is extremely expensive for them since it usually involves financing receivables for 60 days or less. This can cost the small business owner as much as 8% per month or if you extrapolate to a year, it would be 96% per year.
Purchase-order financing is less expensive at 3.5% for the first 30 days and 1.25% for every 10 days thereafter. This approach could result in a 40% interest rate per annum. Small companies like the quick loans, however, they have to deal with the high rates and the risk associated with the lender since the borrower is using their credit lines and cash to run the company’s business. This method of financing relies on the fact that the orders are tied to written guarantees from a buyer that it is committed to purchasing a product.
Purchase-order financing companies are scarce and overall numbers on their business are difficult to acquire. An illustration of a small purchase-order operation is Hartsko (Times article). The owner (Eitelberg) left his garment business and started his company with $1 million from investors in 2004. After a modest start, Hartsko loaned $60 million in 2007, $84 million in 2008 and $150 million in 2009. Mr. Eitelberg estimates that Hartsko will lend out $240 million in 2010 and profits will be in the high six figures.
It will be interesting to see how and when President Obama will demonstrate his promise to provide $30 billion to community banks to make loans to small businesses. The issue, according to the Times article, is the fact the underwriting criteria has become too stringent. The point will be how services can be provided to small businesses that improve their ability to improve their credit by meeting realistic underwriting criteria.
There has to be new methods in the digital environment that streams line the process. The complaints that have made with respect to SBA loans relate to the slow processing has been and delays in obtaining the loans. The primary issue for small businesses is obtaining working capital and the difficulty in maintaining sufficient cash flow to sustain the business. These issues will have to be addressed, as well as, other approaches that can allow the small business to survive during economic down turns.