Want a Small Business Loan? Understand the Private Capital Markets

By Craig R. Everett, Ph.D., Pepperdine University’s Graziadio School of Business

The smallest of businesses, often referred to as micro businesses, still have the hardest time accessing capital, especially those with revenues less than $500,000. A joint Pepperdine/Dun & Bradstreet Credibility Private Capital Access (PCA) Index report released earlier this year indicated 63 percent of these companies said poor financing conditions continue to restrict their overall growth. The study found that the smallest of businesses are increasingly relying on their personal savings and investments, with 44 percent of respondents saying they transferred personal assets to finance business ventures.

On the other hand, they anticipate getting that financing won’t be easy – and, according the Pepperdine survey, those difficulties could stall the small shops’ plans to expand and hire. If financing doesn’t come through, some say they will hire fewer employees than planned (47 percent), others will do layoffs (13 percent), while some even say that selling business assets/shutting down (19 percent) is a possibility.

In fact, many respondents said they could use a little help here from their home states. Less than half – 49 percent – of respondents said they think their state supports business policies that benefit their businesses and 73 percent thought their states should be more involved in making capital more accessible to businesses. Only 40 percent of responding businesses think they have access to information about capital programs in their states.

Since access to capital appears to be the limiting factor, what can small business owners do to increase the likelihood that they will qualify for a loan?  What public policies would help?

There are some additional points that small businesses should understand when navigating the private capital market:

Understand market segmentation. Private capital markets are segmented by geography, size of investment, industry, and risk. Business owners need to do some homework before approaching potential investors to determine what type of capital they are best suited for. For example, don’t waste time trying to get private equity money from if you are a very small business looking for growth capital.

Starting preparing at least six months in advance. It takes time to get your financial house in order. Don’t wait until the last minute to prepare before a meeting or presentation with a potential investor. Start cleaning up your financial statements at least six months prior to pitching your company to an investor and make sure you can articulate your business plan and future financing needs.

Hire an advisor that understands fee structures on loans/investments. You don’t have to go at this alone. There are professionals who can help ensure that you are targeting the best potential source of capital. Small business owners don’t have wait to waste time or enter into a deal that is not advantageous. Hiring an advisor to help wade through the process and provide expert advice can help streamline the process and ensure you are on the right financing track.

Here are three ideas on public policies that also could aid small businesses and start ups:

1. Resolve uncertainty and formalize crowdfunding regulations. More than a year after President Obama signed the JOBS Act into law, the Securities and Exchange Commission has yet to formalize rules that would allow small companies to sell shares over crowdfunding platforms. While many businesses use crowdfunding to raise money they currently can only offer a reward, not an equity stake in the business, in return for the investment. Formalizing crowdfunding regulations will further stimulate investment and provide certainty to small companies who cannot access capital from more traditional lending sources. So far, the only crowdfunding rules that the SEC has formalized relate to how businesses can advertise to accredited investors (who were already allowed to participate in equity crowdfunding opportunities).  To date, equity crowdfunding has not been opened up to any investors that were not already allowed to invest under Reg D.
2. Require more transparency surrounding minimum thresholds required to obtain capital/loans. Posting a minimum threshold for a fixed charge coverage ratio (or any other required ratio) to qualify for a loan will help businesses understand from the outset if they are even qualified to apply for the loan. Making this information more transparent is an important step in enabling businesses to understand what the parameters are for accessing capital and if they stand a chance or if they should look elsewhere.
3. Offer more educational opportunities on how to strategically navigate the private capital markets. Many small businesses owners are experts in their line of business – construction, printing, food and beverage, etc., but they may not know the best way to go about securing financing. The Small Business Administration offers a number of programs and services, but we need more seminars, workshops and hands-on training to ensure that all small business owners have access to education and resources they need to make sound financing decisions.  

Craig R. Everett, Ph.D. is an assistant professor of finance at Pepperdine University’s Graziadio School of Business and Management and the director of the Pepperdine Private Capital Markets Project. @GraziadioSchool.