One of the largest banks in the country, with branch locations in your town, advertises everywhere. You know their jingle. Those ads are tempting for small business owners—it’s hard to resist the ten largest banks because they control over $10.1 trillion in assets and have the marketing budget to prove it. After seeing the ads for weeks on TV, you apply for a small business loan.
Your heart is beating rapidly when you finally receive a response from the bank. You open it, and it’s a form letter that reads, “You have been declined.”
You are now a statistic. The Association of Enterprise Opportunities, a national organization that advocates for micro business development, states that roughly 8,000 business loan requests are declined each weekday in the United States.
Big banks favor big loans
The odds of a startup getting a loan from the largest banks in America aren’t favorable. A Harvard Business School report, “The State of Small Business Lending: Innovation and Technology and the Implications for Regulation,” declares that large banks approve only 33 percent of loans under $100,000, compared to 60 percent approved by small banks. This finding was based on a FDIC survey of business owners.
The explanation for the discrepancy is simple: large banks are focused on sourcing and scaling loans over one million dollars, cross-selling products to their customers, and driving down costs through standardized operating procedures and technology.
But don’t fret—community lenders are helping small businesses.
Meet the community lenders
Community Development Financial Institutions (CDFIs) are one type of community lender. CDFIs may be credit unions, economic development entities, nonprofit lenders, small banks, microfinance lenders, venture capital firms, or community development corporations focused on low- to moderate-income housing.
They are usually nonprofit organizations committed to the mission of making capital accessible to the communities they serve. Often when a bank says no to a small business, a community lender will find a way to say yes, because their focus is on the community, not on a return on investment to shareholders.
The U.S. Department of the Treasury oversees the CDFI program, which was established in 1994 to make capital accessible to struggling communities. CDFIs fix the problems that are not addressed in a responsible manner by the private sector, such as access to affordable credit, financial products geared to the unbanked population (not served by a bank or similar financial institution), financial literacy training, affordable housing, and community development.
The Treasury website states, “Mission-driven CDFIs fill these gaps by offering affordable financial products and services that meet the unique needs of economically underserved communities.”
Once they approve a certified CDFI, the Treasury makes investments in it through a competitive grant process. Upon receiving government funding, the CDFIs leverage these funds with private sector monies to offer small business loans and community development projects. To increase success, CDFIs provide ongoing technical assistance and education to their business clients. The technical assistance and workshops help improve business skills in strategic planning, accounting, and marketing to ensure the business will be sustainable.
Community lenders can be found across the country, from Opportunity Fund in California; LiftFund, with offices in Texas and the southeast; Business Center for New Americans in New York City; and Coastal Enterprises, Inc. in Maine. Accion also provides microfinance and larger loans to small businesses throughout the United States.
During 2016, CDFI fund appropriations generated $2.1 billion in loans and investments, which led to the creation of 28,000 jobs. CDFI program awardees financed 13,300 businesses. Chances are there’s a community lender near you. To find a CDFI, visit the Opportunity Finance Network.
Do your homework
Before you apply for a business loan from a community-based lender, do your homework. Make sure you start at least 60 to 90 days before you need the funds because the process does take time. Search for community lenders in your area. When you find a potential lender, schedule a meeting. This will give you an opportunity to ask questions about the lender and get familiar with their loan process.
Ask them about the loan products they offer (lines of credit, term loans, or commercial real estate financing), the interest rate, and lending terms. Ask about loan fees and whether there is a prepayment penalty for paying a loan off ahead of schedule. Expect the interest rates to be higher than at a bank by a few percentage points, but when you add up all the benefits of working with a community lender, they generally outweigh the negatives.
Make sure your financial house is in order. You’ll need three years of personal and business tax returns (if the business is three years old), a business plan with financials, including a recent profit and loss statement (sometimes referred to as P & L or income statement), balance sheet, cash flow statement, and a brief description of how the funds will be used. For background, be sure to read up on the key elements of the financial plan. Update your resume and highlight the experience you have that will make your business a success. Your loan officer at the community lender will help you complete the application process.
Prior to applying for a loan, review your credit report by requesting a free copy from each of the three major credit bureaus: Equifax, Experian, and TransUnion. Know your three-digit credit score; the higher the number, the better. A score of 680 or better is desirable. Visit Annual Credit Report to get started.
Each credit bureau is different; the information contained in one bureau report may not be the same in the other bureaus. Inaccurate or derogatory information should be removed by going through the formal dispute process, which starts by completing a form—another reason to give yourself plenty of time to get through the loan application process.
Be mentally prepared to personally guarantee the loan. This is necessary should you default on the loan. The personal guarantee gives the lender the ability to go after your personal assets to get the debt paid in full. In addition to the personal guarantee, the lender will want collateral to secure the loan. All loans are secured by collateral. The most common form of collateral is a personal residence when it has equity in it (market value minus the outstanding mortgage equals equity). Lenders can secure loans with equipment, a stock portfolio, or other assets. Community lenders tend to be more flexible than most banks regarding collateral and will work with you.
Respect the process
During the underwriting process, your loan officer reviews your application and determines your credit worthiness. During this phase, the lender will pull a copy of your credit report from one of the credit bureaus. Lenders don’t want surprises or to play detective. Disclose negative information early in the process; if you don’t, you may lose the lender’s trust.
For example, maybe a family member was sick and you used credit cards to pay for their medical care. As a result, several late payments appeared on your credit report and a collections account for $200. Disclose this information and provide a brief written explanation of what happened. Explain that the account was paid-in-full and provide documentation. Your lender will appreciate your candor, and will be more inclined to fight for the deal with higher-ups.
Historical financial performance and cash flow must demonstrate that the business can service the debt on the proposed loan. Cash flow from the business is the primary source of capital to repay a loan. A community lender will put more weight on projections for a startup. If you can’t demonstrate that the business can pay the loan from cash flow, you will be declined.
Learn to respect the process. Each lender has its own rules, process, decision-making, and loan documents. Don’t get frustrated by the paperwork or the time it may take from the initial introduction to the funding of the loan. Focus more on the end goal, receiving “patient” (long term) capital at a reasonable interest rate and terms. There may be faster ways to procure capital, but as a rule, they will be detrimental to the long-term health of your business.
Learn the 5 C’s of credit
The lender will evaluate you on the five C’s of credit:
Character refers to the applicant’s track record for paying bills on time. Also, it is a blend of the applicant’s general trustworthiness, credibility, and personality. Lenders insist on working with people they can trust.
Capacity is the ability to repay the loan from the cash flow of the business and the overall financial wherewithal of the applicant.
Capital is your contribution to the project. Lenders don’t want to finance 100 percent of a project. They want to see you have some “skin” in the deal.
Collateral is the assets securing a loan that give the lender confidence the deal is worthy of funding.
Conditions refers to how the funds will be used as well as economic and industry factors that could impact the loan. For example, it is hard to finance restaurants during a recession or in times of industry overexpansion.
People who really care
Instead of running from bank to bank hoping to get a small business loan, explore community-based lenders. CFDIs and other nonprofit lenders are in every state, and they are focused on serving their communities in a way that will expand economic activity. They know the community and their decisions are made locally.
What you will find is that community lenders don’t spend big bucks on promoting themselves, but the odds are you will receive the loan you need to build your business from people who have your back.