The Credit Outlook for Small Business

Observers of all stripes say the financial crisis is making the credit climate especially cold and difficult

Over the past year, the economic downturn and the frozen credit markets have harmed small business owners' access to get loans and credit lines. While the severity of the effects on entrepreneurs are still being debated—with some noting that credit has always been difficult to obtain and others finding the tightening typical after an economic expansion, an important question is, what will the climate look like in 2009? BusinessWeek's Stacy Perman spoke to a spectrum of economists, academics, entrepreneurs, and lenders who offered their predictions. Edited excerpts of their conversations follow.

Bill Dunkelberg, chief economist, National Federation of Independent Business, Washington

Last year's balance sheets won't look so good, so next year people will find it harder to get credit or their credit worthiness will depreciate and the loan pipeline will decrease. The percentage of companies planning capital projects has dropped to historic lows. It's just not a good time to be borrowing money, and we won't be seeing much change in the current situation in credit availability or lending criteria. It will be tough to try and get a loan with big banks like Bank of America (BAC)—they made a lot of mistakes and are short on capital. Small community banks are the way to go. We let the big banks get so big that they are too big to manage and that means too big to fail.

I am the chairman of the board of a little bank and we still make loans. In fact, our loans grew 30% this year. We don't have the kind of stupid stuff Wall Street invented—we are in the business of savings and lending. [Of course,] business is tougher now, and we have a record number of [small businesses] whose own sales are in decline and that will impact their balance sheets.

Mitch Jacobs, CEO, alternative lender On Deck Capital, New York

It is going to be extremely challenging. Historically, small business owners have been in a credit crisis since 1776, and the events here in the U.S. and around the world are taking that difficult funding environment to new heights.

Even prior to the credit crisis, access to capital from banks for small businesses was extremely limited. Most relied on alternative sources to meet their capital needs. We have always woefully undercapitalized this critical segment and now it's even worse.

I think there will be a critical shift in how we look at the capital markets and begin focusing on the product that will fix the broken relationship between lenders and borrowers. If climate change results in innovation like clean technology, then the financial crisis will result in innovation in financial services. Just pumping money into system will not solve the problem.

Dennis Ceru, professor of entrepreneurship, Babson College

I am looking out my window, and the falling snow reminds me of the financing climate for small business loans: cold and difficult. I think the appetite for lenders in general is very dried up. Lending for small businesses, which has always been difficult, will just get more difficult in this environment. The traditional forms of small business financing have always been family and friends first, followed by angel investors. As a business starts to grow, hopefully it will have access to lines of credit and actual bank loans, but I do not foresee that happening without the owner's signature, which makes it a personal loan.

I don't think that it is going to get any easier in 2009. I expect, as some businesses' credit lines are up for renewal, they may be asked to provide another set of materials to prove they are creditworthy and/or their terms or rates may change.

Matthew Parente, president and founder, Aperio Marketing, Austin, Tex.

For 2009, as long as small businesses do apply for credit while their businesses are still in good standing, it will be a relatively easy thing to do. But I'd say that small businesses need to get to it in the next two to three months. If they wait much longer, people are going to start to get much more nervous by the middle of the year—when it will be the darkest before the dawn—and it might not be until the end of the year before credit begins opening up again.

I recently got a line of credit from Capital One (COF), a midsize regional bank in the Southwest. My marketing consulting business is less than a year old, and I wanted to build up a credit history for it. It was fairly easy. I walked in there one day before the Fed cut the rate. I told them my situation and that my business had no credit history and asked how could I build it up. They were very forthcoming with information and advice. It was incredibly easy. I basically got a 3.99% interest rate. Usually, businesses have to wait 18 months before a bank will look at you. I am the guarantor for the credit line, but it is for the business.

Martha Doron, associate professor, School of Accountancy, College of Business at San Diego State University

The traditional way for small businesses to get financing is to go to credit unions and smaller banks, but they will still be seriously looking at the risk to see if it is worth it. The big banks have their own internal problems. I think the government will be more of a player with the Small Business Administration perhaps becoming a direct lender—it is something that is being talked about. (As opposed to going through banks, but they, too, will want to see a plan.)

It has always been the case that banks are not willing to offer money when one needs it the most. New companies looking for cash still have to look at alternative methods—banks do not want take the risk. Companies that are finding good projects are finding some money, and those that want to expand and have a track record will find help.

As harsh as it sounds, those who are caught in this downturn will have to rethink their plan for survival and ask themselves if they are offering a product or service that the market wants. If not, you don't want to be taking out a loan because not only will you owe money but you will lose your business.

Alissa Bayer, owner and founder, Spa Partisan, Austin, Tex.

I think next year it is going to become much more difficult. Even with loans with Small Business Administration backing, banks are still incredibly careful and much less willing to take unnecessary risks.

I had been following the economic news and saw this coming, so I sought out a line of credit at Frost National Bank, where I already have two sizable business loans. I chose that San Antonio bank because it was not involved in derivatives and its investments weren't compromised. I wanted to make sure my line of credit would still be honored. I've heard of other small business owners who have had their credit lines cut completely. I took out the credit line to have a cushion in place as the economy was slowing down, which was happening at a time when my business was getting bigger. I wanted to make sure that I had it in place before I needed it and the credit markets tightened up.

My line of credit will cover half a month's operating expenses. I am looking at what to do if I need more. I am doing my disaster planning—plan B, C, and D. I am looking at taking my money out of my 401(k) and using it to invest in my business as a way to access additional funds.

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