The bankers are saying “We’re lending!” but the small business owners are saying “No, they aren’t.” There clearly is a disconnection. Here are some considerations if you or someone you know plans to either start a business or expand one.
Recessions can bring out the entrepreneurial spirit in people who have faced unemployment or underemployment long enough to take a risk and start their own businesses. Some will succeed, some will fail, but all need financing. Joseph A. Donofrio, First Vice President in the Commercial Business Lending department at First Niagara Bank, says “A lot of people don’t realize — even though we tell them — how hard it is to start a business and make it successful.”
You may be surprised to know that unemployment benefits may not be available to someone who decides to start their own business. Each state has its own set of criteria, so it’s advisable that the applicant learn their state’s program guidelines prior to starting their business to ensure that benefits, if available, can be received if the applicant has complied with the state’s requirements.
Many small business owners rely on credit cards and/or home equity loans to finance their ventures. In the case of credit card financing, the interest rates can be substantial and the interest generally isn’t tax deductible. Home equity loans can provide a tax-favorable form of financing, but may put the business owner’s home at risk — a risk that may not be acceptable to the business owner’s spouse or partner. “The level of debt and the kind of debt, it’s the combination that’s the problem,” says Steven Cohen, Deputy Commissioner at Empire State Development. “(Small business owners) may not obtain enough and the right kind of financing.”
According to Cohen, from 2006 through 2010, the number of small business loans declined by 65 percent, and the dollar amount of those loans that were approved declined by 55 percent. Small Business Administration lending has started to rebound, “possibly due to improved processes and procedures,” Cohen stated. “But, bank lending is still only a fraction of what it used to be. It’s not only a supply of capital, but demand for capital.” Most banks, especially since the recession, have become more cautious in their lending and typically shy away from start-up businesses to limit their risk.
So what is an entrepreneur to do?
Judi Nolan-Powell, retired Business Relationship Manager for HSBC Bank USA, emphasizes the importance of working with a lender, especially one who has “an appetite for your particular business.” Nolan–Powell advises hopefuls to “be bankable; do your business plan, do your homework; you have to prove yourself.”
Donofrio, Nolan-Powell and others advise small business owners to work with their local Small Business Development Center (SBDC) to develop their business plan. “There are so many resources available that are either reasonable or free,” says Nolan-Powell. The SBDCs are part of the Small Business Administration (SBA), which also supports small businesses through counseling provided by local women’s business centers and volunteers of SCORE (Service Corps Of Retired Executives). Cohen says that business owners must be prepared to demonstrate their need for capital and planned use for it. They must have a proven track record and possess collateral to bring to the lending relationship. Donofrio advises entrepreneurs to “do their due diligence, track cash flows, develop and execute a marketing strategy” and, if they do use credit cards for business expenses, to track such expenses, preferably using only one or two cards solely for business; this is helpful if/when the business owner wants to refinance such debt through one of the programs offered through the SBA.
The Small Business Jobs Act of 2010 identified two main areas new business owners need — start-up financing and refinancing (especially when credit cards are used initially). The SBA doesn’t provide financing, but does provide financing options and guidelines to small businesses such as guaranteed loan programs/debt financing, surety bonds to contractors, and SBA’s Small Business Investment Company (SBIC) Program; a public-private investment partnership through the SBA whereby venture capital is made available to small businesses.
Many states are facing fiscal crises of their own and have tried to increase access to capital as a means of increasing tax revenues from businesses that are looking to expand operations. New York State, for example, offers a “Linked Deposit Program” — a public-private partnership that provides existing businesses with affordable capital through bank loans offered at reduced interest rates. Qualifying businesses enjoy a two to three percent interest rate reduction from prevailing rates, based on the type of business, number of employees, as well as the geographic location and type of ownership. These bank loans are subsidized by corresponding "linked" state deposits. Borrowers may obtain up to $500,000 per loan, with a lifetime maximum of $2 million.
There are also “Angel Funding” sources — venture capital funding groups who provide funds for small business owners, but who may also want a part of the business’ profits in return. “It’s hard to find but it’s out there,” Donofrio says.
FPA member Amy Jo Lauber, CFP®, is President of Lauber Financial Planning in West Seneca, NY.