I read an older article last night that annoyed me. The article was “Why Small Businesses Have Trouble Getting Credit.” Of course, I was interested in the subject and always seek to understand the dynamics of small business lending. As a faculty member of LSU’s Graduate School of Banking, I teach Small Business Lending. These types of articles are an important part of my personal growth. But, this article didn’t enhance my understanding of credit, it annoyed me.
The author stated his case by casting blame at the financial institution, and away from the small business owner. The myth he was perpetuating was one where the system is stacked against the small business owner, so why try. He made three points. Each one was an excuse for the small business owner and a jab at the banking industry. I can’t dispute everything he said, but I can say he didn’t address the most critical factor in each loan application, the financial health of the small business. Instead, he listed these factors.
1. The number of employees your company has is an indicator of risk.
The author implies that smaller companies has less access to capital than larger companies because having fewer employees is a direct reflection of the longevity of the company. Simply put, the fewer number of employees you have, the more likely it is you will fail.
While working directly with lenders over the past several years, I have yet to see this correlation in action. In 2012, a 13 person start-up sold for $1 BILLION. Prior to selling, the company closed $50 million in funding within the first 2 years of operation. I’m referencing Instagram, which is a grossly exaggerated example, but it reinforces a point that a healthy business has value, regardless of the number of employees it has. Each industry is different, and every company has its own model. Financial analysis is agnostic to factors like number of employees. Does the business cash flow and can they service the amount of debt or provide a return on investment? That is the main question.
2. Smaller loans were too costly for banks, so they choose not to fund loan requests for lower dollar amounts.
His second assertion claims that since banks costs are relatively fixed, they choose to focus on larger clients to earn higher profit margins on the bigger loans. Therefore, they prefer to target $5 million dollar loans, not $50 thousand.
The truth of the matter is that banks want to give business loans. This is the product they sell to make money. Many of the bankers I talk with would love to only fund $5 million loans, and make their production goal in a couple of big deals. None of the bankers I talk to will forego a quality application for $50 thousand. Let’s face it, the big deals are out there, but there are thousands of smaller ones that can be funded as well. The bank wants to loan money, and more relationships creates a well-diversified portfolio that mitigates the risk of a singular large client focus. The real question is, “Does your small business meet their credit policy thresholds?” If the answer is yes, then you have a pretty good chance to be funded regardless of the size of the request.
With that in mind, the bank that you choose to apply for a loan matters. Most of the larger banks prefer to deal with larger accounts for the reason the author listed above. It’s efficient and profitable. So consider using a bank that likes to operate with your size of loan request. There are numerous community banks, regional banks, or alternative lenders who specialize in making small business loans. Make your decision to select a bank partially based on the types of businesses the bank likes to work with.
3. Evaluating small business loan applications is too expensive because of the small business owner’s lack of sophistication in presenting his financial information.
The final claim suggests that it’s time consuming to construct the story of the business through their poorly crafted financial statements. Additionally, small business owners may intermingle personal finances with their business, making it difficult to determine the actual situation. He states, that these types of loans require monitoring and personal relationships with the business owner to be successful. The implication is that bankers don’t have the appetite to work with small business owners.
I’m not quite sure how to address this one. At first glance, this seems like an insult to both the banker and the business owner. It makes the banker seem pretentious and unwilling to work with the lowly small business owner, because it is messy and time consuming. On the other hand, it says that the small business owner doesn’t have the capacity to create a clear financial picture of his business. Even the claim that mixing business and personal expenses creates a significant challenge for bankers is slightly off base. Many of those types of transactions are at the guidance of an accountant who is trying to minimize the tax exposure of the business. These are often easy to identify, and bankers simply add them back into the income statement to calculate a company’s free cash flow.
There may be hints of truth in each of his claims, but my advice to the small business owner is to reject the myths of why you can’t get credit for your small business. Those listed above are most likely not the reason. You can get credit, but you have to have your financial picture in order. Ask your banker for the things they look for in a great loan application. The banks want you to be happy if they can help. They have certain financial indicators they are looking for like your debt to equity ratio, the company’s EBITDA, your debt service coverage ratio, the amount you already have out in credit, your current and quick ratio’s, your current free cash flow, and others. The strength of your balance sheet matters. Understand the factors that the bank finds risky, and work to make your company more attractive in their eyes. If you don’t know where to start, just ask your banker.