What’s the future of small business credit?
We’ve been writing and thinking a lot about this lately. It’s a peculiar time: We’re in the middle of a recession that was incubated by several years of too-easy credit. When loose lending caught up with banks and other finance companies, they pulled back sharply, and continue to raise credit standards for business borrowers. At the same time, regulators are beginning to get serious about stopping abuses in the credit card industry, though the reforms leave out small businesses.
1) Shift toward smaller institutions. Community banks and credit unions are among the most ready lenders right now, because they avoided the riskier securities that blew up the big banks’ balance sheets.
2) Unsecured credit is disappearing. Business owners often use consumer credit – their own credit cards or home equity loans – to finance their companies, but those sources of credit not secured by business assets are drying up.
That second trend is worrying, because small business’s credit needs are changing. More and more companies sell services rather than products, and business takes place online. It takes less money than ever to start these types of ventures, but their costs aren’t things that banks are used to financing. I think of it like this: Secured bank loans are Business Credit 1.0. What’s the 2.0? Instead of vehicle or equipment loans, these entrepreneurs need to pay Web developers and buy server space. Instead of inventory financing, they need to buy Google ads on search keywords. That often means they need less money than companies making widgets, but they don’t have hard assets to use as collateral. Try explaining to your banker that you need a line of credit to buy $20,000 worth of paid search ads each month.
That explains why credit cards, an easy source of unsecured debt, became so popular. But credit cards aren’t stable financing. (The NY Times has a good story this morning about what happens to small business owners when their credit card companies reduce their limits.) Most business owners I speak to who borrow on credit cards say they wish they had better alternatives.
It seems like there’s a clear market need for new types of small business financing. So let’s start a discussion. What does the future of small business financing look like?
Here are some ideas to get started:
Kiva and other peer-to-peer lenders. The industry has run into problems with regulators and higher-than-expected charge-offs. But Kiva’s success overseas shows the model’s potential, and the company just began funding US entrepreneurs.
Community development lenders. Focused on lending in communities poorly served by banks, CDFIs are mostly nonprofits and don’t require the same level of returns that commercial banks do. Could the CDFI model be broadened to become a mainstream source of credit for businesses in all communities?
Crowdfunding. Not too far from peer-to-peer lending, but in this case business’s customers are also financiers. An unproven idea to be sure, but it could work for the right type of venture.
What other creative sources of credit are entrepreneurs using? Which ones can scale? What does Small Business Credit 2.0 look like? Tell us in comments or on Twitter.