As politicians posture, small business faces a looming working capital crisis. But it may be a crisis with a hidden benefit: the emergence of a greater variety of ways to get access to cash.
Corey and James speak with CFO.com about the possibilities for alternative lenders.
Frantic talks continue today in Washington to head off the now-famous sequestrationmandating some $85 billion in blanket federal-spending cuts scheduled to begin at midnight Friday. But there are some people who may be less than upset about the inability of Democrats and Republicans in Congress to abort or even modify it: alternative small-business lenders.
When the impact of the sequestration begins affecting small businesses, cash is going to become increasingly hard to find, and working capital needs will grow. This month the White House released a fact sheet warning that “the automatic cuts triggered by a sequester would reduce [Small Business Administration] loan guarantees to small businesses by up to $902 million.”
According to a study conducted last summer by George Mason University and Chmura Economics and Analytics, if the sequester takes full effect, “GDP growth in 2013 will be reduced by two thirds and unemployment will increase by as much as 1.5 percentage points.” Especially hard hit, the study says, will be businesses serving the Department of Defense and those businesses’ downstream suppliers.
If the sequester cuts are fully implemented, the study says, “more than 2 million jobs could be lost, with nearly half of those coming from small business.” In anticipation of falling employment, the report warns that the rate of personal savings will rise, “taking more spending out of the economy.”
If savings rise, people will spend less. If jobs are lost, people will have less to spend. Small business’s customers, who already are paying late, will pay later. That would extend the accounts-receivable cycle for small businesses, which in turn will force them to extend their own accounts payable, throwing a gorilla-sized wrench into the operating cycles of all businesses and negatively affecting working capital. (In a recent report by Sageworks, a financial-information firm focusing on private companies,average accounts-receivable days have increased for U.S. private companies from 37.9 in January 2012 to 45.3 in January 2013. In the construction sector, accounts-receivable days have risen to 61.) The shortfall that emerges between accounts receivable and accounts payable usually is covered by internal net profits or, more often, by externally borrowed funds.
So if SBA loan guarantees are cut, where will those small-business borrowers go?
That’s where the alternative lenders — and the providers that serve them — come in. “We’re talking to banks all the time,” says Cory Ross, vice president of sales and co-founder of BBC Easy, a software-as-a-service outfit that automates the borrowing base certificate calculation for both lenders and businesses by integrating with and pulling relevant information from Quickbooks, Sage, Peachtree, and a variety of other commonly used accounting systems. (Borrowing base certificates are forms put together by borrowers that report the current state of their collateral.)
What Ross is seeing, he says, is “a trend of small-business loans not being made.” He says his firm has heard from banks that want to lend more to small businesses.
“We’re hearing from banks that they want to expand small-business loans, but the biggest idea we’ve heard from them is approving loans based on an owner’s personal credit score,” Ross adds. That, he suggests, is not a terribly innovative idea, and it’s certainly a limiting factor for small-business owners who have maxed out their credit to keep their business running.
It takes a bank just as much effort to approve a loan for $50,000 as it does for $5 million, explains BBC Easy chief executive officer and co-founder James Walter. That makes it difficult for a small business to get a bank’s attention.
“Bankers are incented on the profitability of their loan portfolio,” says Walter. The time a banker has to spend underwriting a small loan eats into that profitability. “Banks love small-business loans because they renew annually; the banker touches it once a year; the bank gets a customer’s checking account, a credit card: they love these accounts. They’re just completely inept at doing them.”
BBC Easy’s value proposition is that it speeds up underwriting through automation, while mitigating risks. Because a business’s data comes directly from its accounting system, fat-finger errors are eliminated and the risk of fraud is reduced. That increases the profitability of those small loans.
But almost every U.S. bank is tied into the SBA program. If that gets cut as a result of the sequestration, “it will make banks even less likely to make small-business loans,” says Ross. That, he adds, will push small-to-midsize businesses toward alternative-lending models.
“Small businesses under contract to the [DoD] or other government agencies will be hardest hit,” he continues. “If you’re a lender working with a company working with the DoD, you have to be extra careful with your underwriting. But a lot of these small-to-midsize businesses live check to check, and even a 60- or 90-day delay [in getting a loan] might be enough to bury them. Some businesses aren’t going to make it, and the ones that do will have to find capital to ride it out.”
Technology may accelerate the pace with which banks can underwrite small-business loans — and help some businesses “ride it out.” But the risk-aversion that set in with the Great Recession still holds many commercial banks in its grip, leading small businesses to look in other directions to finance their daily operations or take advantage of growth opportunities.
Invoice factoring, in which a business sells its long-term receivables for short-term cash, has become increasingly popular. According to Factoring Investor, a factoring-industry publication, factoring volume is up 62% during the past five years (or ever since the financial meltdown). Personal asset-based lending is another way small-business owners can raise capital.
For start-ups, which find it tough to obtain lines of credit from banks and that may possess neither personal assets to use as collateral nor the receivables factors are looking for, the sequestration may give the crowd-fund investment industry and online crowd-funding platforms such as Kickstarter and RocketHub the boost they need to go mainstream. (To be sure, crowd-funding is still in its nascency and still awaiting final Securities and Exchange Commission guidelines.)
“If we don’t get capital flowing, we won’t get out of the recession,” says Jason Best, principal of Crowdfund Capital Advisors, a consulting and advisory firm. “We’ve just come out of one of the most difficult economic periods in our history,” he says. “People are saving more than they ever have, they’re becoming increasingly conservative, and there’s no evidence that people will deploy capital in any riskier manner going forward.”
But, adds Sherwood Neiss, a CCA consultant, if a small-to-midsize business is thinking about a new product line, it could put together a limited crowd-fund investing campaign, raising a small amount of capital “to see if there’s interest in the product or service” without having to make (and raise cash for) a large investment. “It could be a way to test a new product line or product extension,” he says. “There’s real power in that.”
Wouldn’t it be a classic unintended consequence of the sequestration if it led to an increase in credit availability through the flowering of an extended variety of financial instruments and funding strategies?
It would be pretty to think so.