Loans R Us

While most of the news in the Wall Street Journal this week was pretty bleak, a small business feature on franchising opportunities talked about an innovative financing idea.  The gist of the piece is because small business lending is so hard to get now, franchising companies are including a service to help you get financing as part of their deal.  According to the article, assisting putting the right borrower with the right lender really makes a difference.  They cite an example of a home health care franchise that was finding less than 10% of their new franchisees could get financing.  Now that they have a program together, they are finding 75% of their applicants can get funding.

While this is good news, it also reminded me that people looking for opportunities beyond their current job (or unemployment) should make sure to consider the details of what it will really take.  I’m going to excerpt a wonderful example here from a blog called Flock Free Nation

Bob has a job where he earns $50,000 a year. He wants to be his own boss so he buys one of the smaller fast food franchises where he takes home $50,000 in profits every year. He is his own boss and he makes the same income as before. Sounds good right? Not so fast.

To have a business where he earns that same $50,000 he had to:

• Pay a franchise fee of approximately $25,000
• Pay $150,000 for equipment and leasehold improvements
• Pay $20,000 for inventory and working capital

The post goes on to point out that while Bob is financing all this, the point of leverage is supposed to be that it earns you a return.  He’s still working the same (let’s face it -- more) hours and he’s getting the same salary.  Now though, he’s got an increase in both risk and expenses.  That said, he’s presumably doing work he finds more rewarding.  The other possibility is that as he gets the hang of running the business, the math will improve.  My suggestion is to at least do this type of math up front, so you’re clear on what you’re really getting into.

My college roommate left a job to run her own company.  She’s doing really well given that it’s a new business and the economy is terrible. She is definitely engaged in a way that she never was in her old job.  However, even she admitted to me, “It’s like the difference between falling in love and being in the relationship.  Now I’m starting to see the flaws…”

Small Business Credit Crunch 2010

The conflicting stories about the availability of credit for small businesses continue.  A new survey released by the Federal Reserve asking small business owners about their access to credit, showed a continuing mismatch between businesses that want to expand and banks that want to assist them in funding growth.  The survey was done in New York, but the sample was designed to match the structure of the US small business market, including that 70% of the respondents had 5 or fewer employees. 

It takes no time at all to find data points indicating the decline in lending is demand driven (that is small businesses aren’t looking for loans these days), but the Fed survey team says that’s not the case. 

The survey found 59% of respondents had applied for credit during the first half of 2010.  That compares to an average of 40% pre-recession.  More than 75% of the applicants received only “some" or “none” of the credit they wanted.  Some of the problem is arguably related to the credit worthiness of the borrowers.   66% of respondents reported they had sales / revenue declines over the last two years.  It is worth noting that the only area where financing was granted more than half of the time was equipment finance.  Clearly "collateral rules" these days. 

In general, there were three factors that were statistically significant in terms of the population ultimately ruled as credit worthy by receipt of a loan.

Firms with a track record did better, and being part of the one-third of applicants who grew revenue through this recessionary period was a big help.  Finally owners who salt away some savings in retained earnings make a better impression on their bankers.  Perhaps most interesting, was the factor that wasn’t a predictor of receiving credit – having had a loan.  70% of the applicants in the sample had been granted credit from the same financial institution  2008.  Of that group only half were approved—the same percentage approval rate as in the overall sample.  One other noteworthy twist is that although construction and retail firms were disproportionately represented among the industries looking for credit, they were granted loans at the same rate as firms in other sectors. 

The authors of the Fed study hypothesize that more banks consistently providing a “second-look program” could yield significant gains in access to credit.  They acknowledge though that this is only in theory.  It may be worth investigating.  The authors of the study also point out that these small firms typically account for about 60% of gross job creation.  The link between capital access and adding jobs is well proven.