It’s been a decade since the financial crisis, yet small business lending has not recovered. Why is this the case? And why is getting a loan so difficult? To learn why, let’s look at two big factors that affect your chances of getting a business loan:
One: It's expensive for lenders to make small business loans
Lenders consider several factors associated with cost each time they decide whether to make a loan:
The Cost of Capital: Lenders need money to make loans for borrowers. For banks, funds are readily accessible. Banks typically offer savings and checking accounts with interest rates below one percent—this is the price they pay to have money available for loans. For other lenders, the money for loans comes from investors expecting a higher return on their investment.
The Cost of Regulation: Since the financial crisis, the U.S. government has passed the Dodd-Frank law that has put tighter restrictions on lending. Lenders face a mountain of regulations and laws they must follow to keep themselves on the right side of the law, which requires know-how and money to pay lawyers. These costs get passed on to borrowers in the form of higher interest rates. Non-bank lenders like StreetShares face different regulatory burdens, but still require the legal expertise to make sure they abide by the rules.
The Cost to Acquire Borrowers: Even the world's largest banks spend money to convince borrowers to do business with them. Lenders look at marketing and advertising expenses as a "cost to acquire" each borrower, which is factored into the borrower’s interest rate.
Two: Small businesses must demonstrate credit-worthiness to get a loan
Lenders also have to decide whether a borrower is credit-worthy to receive the loan, which involves another set of considerations:
A Good Credit Track Record: Borrowers earn the trust of lenders through a successful history of receiving loans and paying them back on time. This track record is the definition of good credit. Younger and smaller businesses looking for funds can run into difficulties because they haven't yet had the chance to build up a good credit history.
See how one small business owner chose how to get funding: Traditional Banking vs. Online Lenders, A Business Owner's Story
Assets to Offer as Loan Collateral: The best type of collateral for a business is cash on hand—as a “liquid asset,” it is an easy asset to exchange for goods and services. Other types of collateral are less “liquid,” such as real estate, cars, trucks, machinery and inventory. Once collateralized, it can be difficult to sell a vehicle or other property, so a borrower should think carefully before tying up their assets with a lien. Collateral is secured by filing a lien with the local Secretary of State, which can involve a lot of paperwork. Hopefully the borrower is not in a hurry to get funded....
A Personal Guarantee: If a business is young with little or no assets to offer as collateral, the owner can pledge his or her personal credit on behalf of the company. When a business owner offers a personal guarantee, he or she pledges to pay back the loan amount with personal resources if the business is unable to pay it back.
A Compelling Story: There are many reasons to lend to a small business that can’t be reduced to raw numbers on a spreadsheet. Unfortunately, many lenders make decisions on the basis of a loan application designed to reduce a business to a mathematical formula. StreetShares avoids this trap by seeking out small business owners with an outstanding backstory. For example, military veterans gain skills, experience, and character from their service that sets them up for success in business.
Although access to funding for small businesses remains a challenge, understanding the landscape can give you an advantage. Hopefully with the above information, along with your own research, you’ll be better informed as you seek funding for your business.
We take a deeper dive into financing for small business in this ebook, “The Basics of Small Business Financing.” Learn more about how to get a small business loan, how to open a business line of credit, or how to get government contract financing. Download your copy today!
This communication is provided for informational purposes only. It is not intended to be an advertisement, a solicitation, or constitute professional advice, including legal, financial, or tax advice, nor is StreetShares providing advice on any particular situation. This is not an offer of credit. All applications are subject to approval, no guarantee of funding.