ONE OF THE SINGLE greatest frustrations for small businesses in America is limited access to capital. A few years ago, entrepreneurs could approach traditional banks with business plans, projections, and a good credit history, and secure reasonable financing under favorable terms in short order. Today, the requirements for underwriting the same loan are so difficult that conventional bank lending is limited to a much smaller percentage that qualifies. This reality is causing a necessary shift in the lending environment.
Traditional banks will begin to see loan requests diminish more and more as entrepreneurs and small businesses pursue alternate sources for capital. One emerging source is private placement capital from individuals who prefer to loan capital to small businesses at higher interest rates than they have been receiving from bank deposit accounts or investment accounts. With the proper presentation and disclosure of the small business performance and opportunity, a private individual often finds the premium interest rate provided by the small business a welcome change from current traditional alternatives. In some cases, these lending programs can grow into opportunities for permanent investment into the small business. The interesting point about this new lending option is that banks may diminish their lending portfolio while simultaneously reducing their customer deposit accounts with those who choose to fund these loans.
The larger scale opportunity for funding is with venture capital resources that often search for emerging businesses that present an opportunity for a substantial return in a specific timeframe. These sources often prefer a business that has been around long enough to establish some element of momentum or proof of concept. Each source may have different business sectors in which they specialize because of their core expertise. If your business is within their core focus and meets the guidelines they target for scale and future potential, there may be a good fit. The fundamental point to remember is that they are often interested in a 20% annual return on their investment. This means that either through interest, dividend or equity sale, they like to fund a program where they can see substantial financial results in 3-7 years. The key to using these sources is related to the strength of the financial opportunity if these funds are provided. Rapid growth models with large payoffs upon execution are typical for these sources of capital.
There are sources that fall between the large venture capital source and the small individual private source. Certain individuals and businesses that specialize in target investing at a scale less than typical venture capital sources are often referred to as “Angel Investors.” These sources often consider mid-range amounts and have more flexibility in how they approach an investment. There may be broader options for length of term, method of return, elements of equity, and other variables to a deal.
The common element that seems to be present in more popular lending sources for small businesses and entrepreneurs is a greater focus and weight on the prospective elements of the opportunity than the retrospective results of the business. In traditional bank lending, the greater focus is clearly on the retrospective financial performance as the primary qualifier that is supported by business and personal creditworthiness. Prospective elements of the opportunity are simply an accent to the process and of very little importance in the loan underwriting by traditional bank lending.
