Why Banks don’t lend to Small Business – Part II

To say small business lending by banks is challenging is a gross understatement.  While economists taut the strength of small business in adding jobs to payroll, anyone that owned any type of business knows small business owners work harder, longer, and eventually smarter if they are going to survive without institutional support.  My friend likes to say small business is the farming of the modern era, it is seven days a week, 24 hours a day, and has all the characteristics of the family farm, except land. Land has been replaced by the Internet.  Hard assets like land and buildings are much easier to value to a banker (or they used to be!).

What can a Banker Lend against

So the ultimate question is “What can the banker lend against with a reasonable expectation of repayment?”

  • Personal liquid assets as collateral for the business loan. Of course the assets have to be liquid marketable securities worth several times the value of the loan so that if the market goes down, there is still enough to cover the loan. Effectively the small business owner is borrowing the money personally and lending it to the company.
  • A U.S. Government Small Business Administration loan guarantee on a business loan, however the guarantee only pays off the bank when the borrower is declared in default.  This means that the bank may have to wait for an extended period of time to get the percentage share of the loan that is guaranteed. Meanwhile the bank has a bad loan on its books, not the first time, but this is a known risk that they try to avoid, rather than a sure thing that turns into a calamity.
  • Credit insurance on receivables means waiting at least 90 days with protracted default before a claim can be made.  There are two kinds of defaults: an actual event of default such as bankruptcy, or “protracted default” which is technical jargon for late payments or non-payment before bankruptcy i.e. the check is in the mail.
  • Factoring which is the collection of proceeds of invoices by a (factoring) company other than the seller.  Factoring is subject to a number of issues, not the least of which is merchandise disputes, chargebacks, and the control of payment dates by the buyer regardless of their previous agreements.

So small businesses are left to focus on how they can turn their receivables into cash.  Receivables are only as good as the cash flow of the buyer, but, and this is important, they are better than inventory if managed properly.  And as bank lending to small business will always be a challenge, voids are being filled by B2B and supplier networks and e-invoicing platforms which create opportunities to finance receivables that have entered the buyers' system and have been approved for payment.

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First Voice

  1. Jon Samsel:

    Nice article, David. Keep em coming!

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