When the owner of a local gift andcoffee shop retired, an employee offered to buy her business. But theirinitial contentment with the arrangement soon turned to despair afterthree banks turned down requests for financing.
Intoday’s struggling economy, when lenders have tightened their pursestrings, this scenario is an increasingly common and brutal reality,making it a challenge for new companies to borrow capital and forexisting businesses to expand.
“Theslowdown in the economy is so widespread that it affects almost everysegment of the business world,” says Mike Miller, senior vice presidentfor Valley Bank. “It is difficult [for small businesses], but notnecessarily because lenders have tightened their lending requirements.”
What Miller and other lenders are seeing is that small businesses—companies with 500 or fewer employees—often lack adequate cash flow to cover operating expenses, are overextended on lines of credit and credit cards, or have experienced a combination of lower revenues, business losses and increased expenses. When lenders see these red flags, they are more cautious about making loans.
In addition, some banks are making their lending criteria and underwriting guidelines more strict because secondary markets like Cantor Fitzgerald and SunTrust no longer buy commercial loans. This means that the originating lender holds the entire risk for loans it can’t resell, says Lyn Hamilton, vice president and Small Business Administration (SBA) loan manager for Heritage Bank in Tacoma. Local bankers expect this trend to continue through 2009 as they await changes from the Obama administration.
However, the coffee shop mentioned earlier was not totally without options. After seeking the help of the Small Business Development Center (SBDC) at Green River Community College, the shop owner was able to negotiate a fair price with the buyer. The seller herself also helped the deal come together by agreeing to finance the loan, facilitating the sale with mutually advantageous terms.
Despite the gloomy outlook from economists this year, small businesses such as this coffee shop still have viable lending options available to them. From traditional bank financing and SBA loans to alternative funding sources, such as private investors, venture capital and seller-financed sales, startups in Washington state still have a wide variety of funding mechanisms that can help carry them through the tough times.
Community banks & credit unions
When searching for ways to finance your big idea, sometimes it’s best to start small. Community banks and credit unions offering commercial loans are often good sources for businesses to tap for funding. These smaller banks usually offer more personal service than large national banks and can develop relationships with their customers by learning about the businesses themselves as well as the local marketplace.
“A smaller company will do better with a smaller community bank,” says Deanna Burnett-Keener, business counselor and director of the SBDC branch near Green River Community College in Auburn.
As a former banker, Burnett-Keener points out that community banks, such as Washington Commercial Bank in Fife and Heritage Bank in Sumner, are more likely to look at smaller business loan applications. These lenders also have more time to spend with their customers because they have fewer loans to service. This situation allows them time to analyze their customers’ businesses beyond lending and credit scores, often making the difference between approving and rejecting a loan.
A local import-export company recently experienced this advantage with the BECU credit union when the business applied for a line-of-credit increase. After analyzing the company’s history and current situation, BECU agreed to give the customer credit for receivables up to 90 days, which is twice the standard amount of time allowed. The credit union then approved the loan.
“The smaller banks really understand. They really listen to their clients and review industry standards,” Burnett-Keener says. “They also develop a comfort level with situations they’ve seen before.”
To choose the right lender, the SBDC counselor advises business owners to consider different types of banks and loan packages as well as the overall banking relationship to find a good match. She suggests visiting a branch near the business and meeting the staff.
Dave Ellis, manager of SBA lending at Peoples Bank in Kirkland, recommends that borrowers also look at the financial position and strength of the bank and then establish a relationship with a loan officer with whom they can relate.
U.S. Small Business Administration
Other companies have found success by selecting the U.S. Small Business Administration as a commercial loan resource.
Jody Hall, owner of Seattle’s Cupcake Royale chain, borrowed SBA funds last year to expand her cupcake and coffee house business. Jennifer Kilgus, the Northwest regional administrator for SBA in Seattle, says Hall is the model business owner for an SBA loan. Hall, Kilgus explains, is an organized, “hands-on,” engaged owner who takes things slowly and has a strong business plan. According to Kilgus, Hall represented a good risk, qualifying her for an SBA-guaranteed loan from a local bank.
As a government-backed lending option, the SBA typically can approve business loans for up to $2 million within 24 hours, Kilgus says. Depending on the size of the loan, 50 to 85 percent of loan value is guaranteed by the SBA, making the loans more attractive to SBA-preferred lenders like Peoples Bank and Heritage Bank.
Last year alone (for the fiscal year ending Sept. 30, 2008), the SBA made 2,179 loans in Washington state for a total of $512.1 million, with an average loan amount of just over $197,000. While the SBA has yet to set loan goals for 2009, Kilgus says the agency has money to lend now.
Alternative funding sources
Aside from traditional banks and government programs, other small-business financing resources exist, including:
- Nonprofit community development organizations, like Community Capital Development.
- Venture capital firms, such as Madrona Venture Group, Cascadia Capital and Pacific Horizon Ventures.
- Angel investor groups, including the Zino Society, Alliance of Angels and Keiretsu Forum.
Another common resource for small businesses is borrowing from family and friends. For the purchase of a business, if traditional lending or personal borrowing aren’t options, the parties might consider seller-carried financing. In this scenario, a buyer makes a 25 to 30 percent down payment and ongoing loan payments to the seller rather than to a bank. Such agreements usually include an option to refinance with a traditional bank in two to five years without a prepayment penalty.
“In the current market, the seller may need to look at being able to carry the contract on the sale of a business for two years,” Burnett-Keener explains. “This gives the economy time to turn around and the buyer time to refinance the sale through a standard bankable loan.”
She also advises small businesses to look for private investors. To find a match, she recommends checking with local banks and investment and accounting firms.
In addition, Kilgus urges business owners to free up cash by adapting their business plans to the current environment and to think beyond the obvious. “What we’re hearing from businesses is they have tried to get very creative with the way they are using their funds,” she says. “They are looking at what’s working and what isn’t.”
For instance, when American Produce of Wenatchee was producing more apples than it could sell, the company retooled and began slicing up the surplus apples for school lunches.
Kilgus and Burnett-Keener also advise businesses to take it slowly, plan ahead, have six months of cash on hand, adopt a just-in-time inventory system, ask for more favorable terms from suppliers, and cut noncritical, nonmarketing-related expenses.
“Do not cut marketing,” Kilgus warns. “It is the worst thing a small business can do.”
What lies ahead
For early 2009, Burnett-Keener expects a “wait-and-see” attitude with very low lending levels and conservative consumer and business spending. She doesn’t anticipate the lending outlook to change much until the details about President Obama’s proposed economic stimulus package become clear and their effects on individuals and businesses can be determined.
“This is a challenging time,” she says. “It’s going to be interesting.”
Kilgus, however, is more hopeful about the economy.
“Overall, there is going to be an increased level of attention paid to small businesses,” she says. “Small businesses are the engines that run this country, and if they aren’t doing well, our economy isn’t doing well.”
Still, she adds, “I’m fully confident that we’ll pull out of this.”