Are You A Part Of The Bubble?

Small-Business Lending in America is broken. There are hundreds of alternative lenders who are offering short term cash and daily debit products with APR’s with a whopping price tag of 40-200 percent, and short amortizations that force borrowers into multiple renewal cycles.

Billions of dollars are being lent annually, and there is an economic bubble waiting to burst which will be bad for our economy and terrible for unemployment. Entrepreneurs typically create 2/3 of all new jobs. The interest rates that so many of them are paying are simply unsustainable.

A vibrant and fair system of access to capital for entrepreneurs is critical to all of our economic future. So what can we all do now to make a difference? I would argue that many larger businesses should consider taking some short term economic pain, in order to enjoy long term gain.

The alternative lenders are happy to spend billions of dollars on marketing and advertising each year. They have the margins to afford it. And publishers are happy to take the money. The term “small business loan” can collect $40/click.

Banks are profiting also. The core principle of banking is that banks are supposed to take deposits, and turn around and lend to businesses in their community at reasonable rates so that they can create jobs. Now it’s become acceptable for the nation’s top banks to create massive warehouse lines for the short term lenders, and the money goes into the market at exorbitant rates.

Credit card processors’ are making untold fortunes promoting these loans over the last few years. I haven’t reviewed the financials, but these large multi-billion dollar enterprises are delighted with the cross-sell revenue. In many instances, they and the brokers will add 12 points to a loan, or increase a borrowers cost by 1/3, without the borrower even realizing it.

Many small-business non-profits are benefiting also. We’re seeing partnerships formed between some of the most respectable NPO’s and very expensive lenders.

Promoting small-business lending is not like offering up staplers or office supplies. If a small-business buys a wrong stapler or pays an extra 50 cents for one, it will not have a material impact on their business. But a bad loan decision can cause long term pain and incredible frustration.

There is an urgent need for education around the concept of a path to bankability for small-business owners and entrepreneurs. It’s understandable that at some stage of evolution a business will not be bankable. But with the right guidance and direction a business can get there over time.

What can we do, both individually and in out respective businesses to prevent this bubble from bursting? What can we do to help solve the problem instead of being a direct or indirect part of it?


How to Cure Entrepreneurial Brain Freeze

Some entrepreneurs spend months trying to raise more money than they actually need to achieve proof of concept.  Many get stuck on the grand vision of their company’s future instead of deploying the resources and assets at their disposal.  I call this entrepreneurial brain freeze.  When I started my first venture, it took me six months to get a meeting with angel investors.  I was so excited that I spent 72 hours straight marathon writing a business plan and financial forecast in order to convince the investors why I needed $2 million to start my company.

I showed up in a fancy suit and tie, and the first thing that the investors did was rip up my forecast and asked me what I could do with just $200,000.  I was initially shocked that they would lowball me like that, but in the end, realized they were right.  This experience taught me, in retrospect, that if I had just tried to raise $200,000 instead of $2 million months earlier, I would have reached the starting line much faster.  I had to cure my own case of entrepreneurial brain freeze.

At my loan-advisory office, we speak with business owners who show the common symptoms of brain freeze: they’re stuck within the confines of their company vision and unwilling to stray from their buttoned up business plans.  Before discussing funding options, we first ask them what they need the money for and why.  The reality is that usually there is a way to meet their objectives with much less money.

The business owner might be foregoing short-term profits by seeking less startup capital, but they are moving commerce sooner, and that is what’s important.  The best proof of a viable business is active commerce, not funding.

A few weeks ago, I met an entrepreneur who wanted to start a golf simulator business.  He wanted to raise money for his own facility, with two owned or leased machines, and also wanted more capital to market his business.  At the time of the call, though, he didn’t even have a proof of concept, no customers on the horizon and yet wanted to borrow or raise a couple of hundred thousand dollars in equity.  I had to take a step back with this entrepreneur instead of pushing him toward a loan that he would later regret.  A better option was to partner with local golf stores by installing his simulators in their shops.  By piggybacking off of the store’s existing customer base, the entrepreneur was drastically cutting his marketing dollars while also achieving a proof of concept in exchange for profit sharing with the existing golf store.

Instead of seeking $500,000 to launch his business, the entrepreneur only needed $50,000 to get started.  This is a much more reasonable goal.

If you’re trying to borrow money before you’ve gotten one customer, you’re likely going to give away more equity than you have to, or it’s going to cost you way too much to borrow money.  There can be huge benefit in shrinking a grandiose vision, shaking off the entrepreneurial brain freeze and proceeding with calculated baby steps rather than rushing a new business the the finish line.

Five Questions to Ask an Alternative Lender

Finding the right alternative lender can make a huge difference for small business.

A good alternative lender is one who is cognizant of their role within the small business industry–a means to an end.  Alternative lenders should act as a bridge for small businesses to get them out of a financial hole and back into a positive cash flow.  A good alternative lender lends the borrower just what they need to achieve this goal, not the max amount that the borrower qualifies for in order to increase payments and interest.

Because we don’t know a lot about alternative lending industry activities–how much they lend each quarter, the terms of all loans, or even who all of the lenders are–what distinguishes a “good” alternative lender from a “bad” alternative lender is a bit of a gray line.

However, there are some definitive things to think about when seeking capital from an alternative lender to decide if they have you and your businesses best interest in mind, or if they are solely focused on collecting payments.  Here are some questions to ask when pursuing an alternative lender for financing:

1.  What percentage of the time do the borrowers need to come back to the lender for more money?  Knowing the renewal rate of the lender will help you determine if it’s likely your business will get trapped in a debt cycle.

2.  What are the prepayment penalties?  Can a customer get out of the loan at anytime with little to no prepayment penalty?  Or are they locked in to paying the balance of the loan for the length of the loan?

3.  What percentage of clients graduate to bank financing?  If this stat is relatively high, it’s a good indicator that the alternative lender is interested in helping business move into loan products that are more affordable with longer amortization periods.

4.  What is the lien structure for the alternative lender?  Do they take blanket liens on all assets of the company, which can make it difficult to borrow money in the future from other lenders?  Or do they take liens on specific assets that they are borrowing against?

5.  Does the lender offer counseling or advice?  Lenders that loan money without any counseling generally don’t have the borrower’s best interest in mind.  A good lender will offer the borrower counseling regarding cash flow impact and making sure that there is a clear plan for the borrower to be able to afford the loan and make the business better with the loan.