Surveying the Small Business Financing Landscape

Over the past month or so, there has been a noticeable shift in the dialog coming out of Washington, D.C. with regard to economic priorities, with a stronger emphasis on job creation.

As part of this emphasis, the federal government has proposed and launched several initiatives to help increase access to capital and grow small business financing. One of these would transfer $30 billion to a new Small Business Lending Fund that could be accessed by community banks.

But is a lack of access to capital what’s really holding community banks back from doing more small business financing? I don’t think so, and neither does Jim Blasingame, the creator and host of The Small Business Advocate Show, the world’s only weekday small business radio program.

“Washington says that banks aren’t lending money to businesses, and if they’re talking about big banks, they’re right,” Jim said when I appeared on his show recently. “But every community banker I’ve talked to says they’ve got lots of money to lend. Access to capital isn’t the problem-the problem is that small businesses aren’t asking banks for loans.”

A recent survey conducted among business owners and executives by Forbes Insights and CIT bears this out. Only 11 percent of respondents said they had sought new lines of credit or small business financing over the past year in an effort to help improve their cash flow. Also, just 11 percent said that their greatest cash flow challenge in the past year was difficulty in securing small business financing, the second-lowest ranked answer in the survey.

While loans are available to help well-run small businesses finance growth and working capital, there’s no question that they’re harder to obtain than they used to be.

In this environment, owners need to be more agile, flexible and transparent. Meanwhile, lenders have expanded their reporting and recordkeeping requirements, as well as monitoring of financial performance. They’re also examining collateral more closely to try to ensure that borrowers can repay their loans.

What Business Owners Are Thinking

The Forbes Insights-CIT survey revealed some interesting findings with regard to how business owners feel about their companies, the overall U.S. and world economies, and Washington, D.C.’s effort to revive the economy:

• Respondents were mostly optimistic about prospects for their companies this year, thought they were more cautious about the overall economy in general. More than half (61 percent) expect their own company’s revenues to increase this year, primarily because the recession has forced them to work harder and smarter than they ever have before.

• More than three-quarters of respondents (78 percent) believe they will have to learn to adapt and do business in new ways in order to succeed in a more competitive marketplace.

• Very few respondents believe that policies enacted by the federal government are helping the recovery. A full 90 percent said that economic stimuli does not benefit small business. However, most (58 percent) do believe that proposals to raise SBA loan limits will be helpful to small businesses.

• Most encouraging is the belief among owners and executives in the power of small business as the main driver of the U.S economic engine. Eighty-three percent believe that small businesses will play a major role in helping lead the economy back to recovery.

What doesn’t kill you makes you stronger, and this seems to be how business owners feel about their prospects for success this year and beyond. “The survival strategies that companies use during a downturn can often aid them during the resulting upswings and make them more resilient,” the report noted.

“U.S. small businesses are looking ahead to 2010 in anticipation that the ordeal of the 2009 recession may be fading,” it concluded. “Having made it through the economic trauma, business owners are hoping that the hard lessons they’ve had to face will provide them with the discipline and control necessary to help ensure their success.”

How Commercial Lenders Went Wrong With Small Business Financing

Small business owners will be more likely to avoid serious future business finance problems with working capital management and commercial real estate loans by exploring what went wrong with business financing and commercial lending. This is not a hypothetical issue for most commercial borrowers, particularly if they need help with determining practical small business financing choices that are available to them. The bankers and banks responsible for the recent financial meltdown seem to be saying that even if anything actually went wrong, everything is fine now in the world of commercial lending. Nothing could be further from the truth. Commercial lenders made serious mistakes, and according to a popular phrase, if business lenders and business owners forget these mistakes, they are doomed to repeat them in the future.

Greed seems to be a common theme for several of the most serious business finance mistakes made by many lending institutions. Unsurprising negative results were produced by the attempt to produce quick profits and higher-than-normal returns. The bankers themselves seem to be the only ones surprised by the devastating losses that they produced. The largest small business lender in the United States (CIT Group) declared bankruptcy after two years of attempting to get someone else to pay for their mistakes. We are already seeing a record level of bank failures, and by most accounts many of the largest banks should have been allowed to fail but were instead supported by artificial government funding.

When making loans or buying securities such as those now referred to as toxic assets, there were many instances in which banks failed to look at cash flow. For some small business finance programs, a stated income commercial loan underwriting process was used in which commercial borrower tax returns were not even requested or reviewed. One of the most prominent business lenders aggressively using this approach was Lehman Brothers (which filed for bankruptcy due to a number of questionable financial dealings).

Bankers obsessed with generating quick profits frequently lost sight of a basic investment principle that asset valuations can decrease quickly and do not always increase. Many business loans were finalized in which the commercial borrower had little or no equity at risk. Banks invested almost nothing in cash (as little as three cents on the dollar) when buying future toxic assets. The apparent assumption was that if any downward fluctuation in value occurred, it would be a token three to five percent. In fact we have now seen many commercial real estate values decrease by 40 to 50 percent during the past two years. Commercial real estate is proving to be the next toxic asset on their balance sheets for the many banks which made the original commercial mortgages on such business properties. While there were huge government bailouts to banks which have toxic assets based on residential mortgages, it is not likely that banks will receive financial assistance to cover commercial real estate loan losses. As a result, a realistic expectation is that such commercial finance losses could produce serious problems for many banks and other lenders over the next several years. As noted in the following paragraph, many lenders have already drastically reduced their small business finance programs.

Inaccurate and misleading statements by commercial lenders about their lending activities for business finance programs to small business owners is an ongoing problem. Although banks have typically been reporting that they are lending normally with their small business financing, the actual results indicate something very different by any objective standard. It is obvious that lenders would rather not admit publicly that they are not lending normally because of the negative public relations impact this would cause. Business owners will need to be skeptical and cautious in their efforts to secure small business financing because of this particular issue alone.

There are practical and realistic small business finance solutions available to business owners in spite of the inappropriate commercial lending practices just described. The emphasis here is focusing on the problems rather than the solutions primarily because of the lingering notion by some that there are not significant current commercial lending problems. Despite contrary views from bankers and politicians, collectively most observers would agree that the multiple mistakes made by banks and other commercial lenders were serious and are likely to have long-lasting effects for commercial borrowers.

Commercial Loans And Small Business Financing – What To Avoid

It is always advisable to have a detailed understanding of what can go wrong with commercial loans and working capital financing. The five factors described can have negative and long-lasting financial results for small business loans and commercial real estate loans. Business owners should be prepared for these real possibilities.

Most commercial borrowers do not want to experience a worst case for commercial real estate loans and small business loans. When present simultaneously, there are five particular factors which will usually result in a serious outcome that is nevertheless avoidable. Understanding each of the issues should enable borrowers to avoid a potentially devastating working capital financing outcome.

Here are the issues which we believe will usually result in a worst case scenario for commercial loans if all five are present: (1) Dealing with an inexperienced commercial finance advisor; (2) Using a lender which historically has an unacceptable track record for successfully completing commercial loans; (3) Obtaining business financing that includes a recall option for the lender; (4) Inappropriate and non-competitive business loan terms; and (5) Short-term financing in which a borrower is not also offered the opportunity to lengthen to a longer-term period.

Our primary advice is to totally avoid circumstances where all five factors exist at the same time. A secondary recommendation is to also seek alternative financing for commercial loans when either of the first two elements are present. There are likely to be many working capital management scenarios where it will be impractical to avoid all of the issues described in the preceding paragraph.

It is important for business owners to secure commercial financing which is not impacted by the worst case conditions. Business owners will subject themselves to inappropriate business financing terms for a very long time if they do not take appropriate action before they finalize commercial loans. There are two points which should be emphasized.

Our first point is that business loans are probably more complicated than realized by most commercial borrowers. There are a number of additional serious commercial funding obstacles beyond those noted in this brief article. Because of this, it is important for commercial borrowers not to narrowly focus on the factors included in the worst case scenario discussed here and simply avoid these specific issues.

A balanced analysis of both the worst case aspects and other critical business finance terms is essential for comprehensive working capital financing. The importance of this overall perspective is why we emphasized the critical nature of avoiding both inexperienced brokers and lenders.

Second, the worst case scenario for business loans described above is totally avoidable. But to avoid an obstacle, it is critical that you have a working understanding of what you are avoiding, what it looks like and any special techniques required to evade it. For example, if you are driving a car, it is common sense that you will not intentionally drive your vehicle over sharp pointed objects that are likely to puncture your tires.

With commercial loans and commercial real estate loans, the combination of the five factors noted previously in this article will typically produce an impact for small business funding that is equivalent to much worse than simply puncturing a tire. Unfortunately, without proper advice and knowledge, most business owners will not be prepared to recognize the appropriate warning signs for avoiding business financing hazards.

In this article we focused on problems with small business financing that will almost always have long-lasting and immediate negative results for business owners. Commercial borrowers should not overlook the multitude of other serious problems with commercial loans beyond those described. As with the circumstances noted above, most of the other potential difficulties with business loans can also be avoided.