Millions of small business owners remain left out in the cold by the same banks that keep their deposits. The survivors of the financial crisis need funds to grow in an improving economic climate, but they face a dilemma of how to fund this growth. A cottage industry offering daily payment loans is maturing inside the wide gap created when the market for bank credit lines and high limit credit cards disappeared.
The likes of Wells Fargo, Bank of America, and JP Morgan Chase have all but eliminated business banker positions serving truly small businesses with under $1 million in gross annual sales (GAS). Their drive to cut costs led them to focus their human capital on the largest and most profitable customers. The six figure credit lines once enjoyed by these customers disappeared in the process.
Five years later, there has been very little retread on this issue by banks, even as smaller customers went outside the bank to seek funding. The banks’ credit card arms remain conservative and high limits remain scarce. A business owner with a 700 credit score or better can’t achieve approvals in excess of $50,000 in today’s lending climate.
The majority of businesses owners in the U.S. have incomes placing them squarely inside the middle class. They work hard and use any profits to pay themselves a living wage. This may not be the dream they had when they hung up their shingle, but most enjoy the freedom of being their own boss more than the corporate rat race. Many are recent immigrants fulfilling their American dream in hopes of passing it to their children and grandchildren.
Small businesses overwhelmingly show little profit after the owners take a salary. Limited balance sheet equity after liabilities are subtracted from assets further fuel large banks’ disinterest in lending to this market.
These businesses are increasingly turning to direct mail, internet pay-per-click banners and TV commercials offering six figure business loans from private lenders. A business showing $100,000 going through its bank account monthly can count on being approved for $75,000 to $125,000 in a matter of hours. Even credit scores below 600 will often receive funding so long as they are not going through bankruptcy. Often all that’s required are a short application, six months of business bank statements and the most recent business tax return available.
The largest players in the industry are private companies including Capital Access Network (www.cancapital.com) and On Deck Capital (www.ondeck.com). Loan terms range from six to 18 months, payments are debited daily and loan amounts range from eight to 10 percent of gross annual sales.
Wall Street has taken a liking to the space. On Deck successfully completed the first securitization transaction in the space in April totaling $175 million fixed rate notes. The firm is financed by top tier venture capitalists including Google Ventures and Tiger Global. CAN counts Nigel Morris as an investor and advisor. Mr. Morris co-founded Capital One Financial Services and helped transform the consumer lending industry.
The reason investors are clamoring to participate in the new market is such loans boast hefty returns on their capital. Many borrowers who get over the initial hurdle of daily payments coming out of their checking account are shocked to hear the cost. A typical loan requires a payback of 30 cents for every dollar borrowed over a short term like 6-12 months. Those are very high rates that look even higher when APRs are considered.
The harsh reality is that small business people don’t have many alternatives outside of friends and family. Home equity is still scarce. Personal credit cards at reasonable rates can wreak havoc on personal credit scores if several accounts are opened and maxed out in a short period of time.
If the money can be turned over two to four times in a given year and the business enjoys margins in excess of 20%, the return outweighs the cost of funds. Materials and inventory purchased at deep discounts can also make sense. Sometimes the money is used to put other creditors or the IRS at bay.
Daily payment lenders have replaced traditional banks as the primary lender to truly small businesses. As this industry expands in the coming years, more competition will inevitably bring about cheaper rates and larger approvals for Main Street business owners. Wall Street is keen to fund the lenders participating in this market place for now as defaults remain very low… until the next crisis.
Working Capital Loans are a commercial-only financial product. Loans are typically calculated by taking the average of the last three months of business banking deposits (lending estimate) or 10% of Gross Sales from last year’s business Tax Return and take the higher of those two. For more information regarding a Bank of Cardiff Working Capital Loan, contact a Bank of Cardiff Analyst via email or via phone (888) 234-0166.