By David Sederholt
Today’s economic environment has contributed to the difficulties small businesses face when trying to secure financing. When it comes to traditional bank loans, small businesses often need to jump through hoops in a tedious application process that could take months. It’s no wonder Main Street is heading to other sources to seek capital.
In one of my conversations with our bankers, it became apparent to me why they find it so difficult to lend money to small businesses. Banks view the world and make credit decisions entirely differently than alternative business lenders, to which many small businesses are increasingly turning for their funding needs. Here is the reality of the financing atmosphere small businesses are facing:
- The term “small business” holds different meaning to banks. Through the eyes of the banks, a “small business” is classified as a company with 500 to 1,500 employees and revenues of up to $21 million. While alternative lenders service a number of “small businesses,” the average size of the thousands of businesses that they finance is far smaller. These Main Street/mom and pop entrepreneurs generally have revenues under $2 million, with most having less than 50 employees.
- Small businesses operate in different conditions. This presents one of the biggest challenges for banks evaluating whether to finance a small business. They operate in competitive markets on slim margins, rising costs and increasing tax burden, and live entirely on the cash flow generated. Most do not reflect on P&Ls until the end of the year when their accountant gives them the news around tax time. It is all about making payroll, paying the rent and keeping on the lights. One month, one week at a time.
- When seeking financing, small businesses are often incompatible with the banks. Traditional banks’ formal structures and regulatory restrictions prevent them from knowing how to evaluate the health of this class of businesses. Economically, it makes no sense for a bank to grant a business loan for less than $250,000, as they don’t make any money on it due to their complex process. In contrast, alternative lenders average financing amounts of $20,000 to $40,000, most of it as working capital to supplement cash flow, in amounts that reflect the size of most small businesses.
- Banks are quantitative in their approach. They look at financial statements, most often prepared by auditors and CPAs. For even modest loans, they want to see balance sheets and three to five year projections of revenues and profitability. All of this is reasonable if you are looking at a company seeking a $1 million loan with 80 employees and $12 million in annual sales. But for the average restaurant, retailer, salon or small manufacturer, this is not only impossible, it’s also not how Main Street businesses operate.
When we started financing small businesses, I stressed the importance of having our underwriters put themselves in the shoes of our clientele. Many of our customers are extremely hard-working entrepreneurs who are in the trenches 10 to 12 hours a day, often six days a week, to run their businesses. They are not accountants – they are focused on running the day-to-day operations and not necessarily working to achieve their five year projections. Their challenges are great and they are worried about making it through each week and month.
These small business owners can and do have healthy relationships with their bankers, but for their financing needs, it’s vital that they chose a solution that fits their economic model and will lead them to achieving their goals.
David Sederholt is COO of Strategic Funding Source Inc., a small business financing company. Previously, he served as a biomedical researcher, restaurant owner, corporate executive, business consultant and owner of a commercial real estate brokerage firm.