Microloans Fall Out as Small Business Lending Dries Up

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The smallest of small businesses find it difficult to raise new capital. According to the Federal Reserve, businesses with fewer than 10 employees find accessing capital nearly impossible.

These small firms require very small capital infusions. According to a recent study, most small businesses of fewer than 10 employees want to raise only $100,000 in debt financing. Amongst bankers, such small loans are regarded as microloans – loans so small that most commercial bankers tend to avoid them.

In general, the loans would be used for a very basic purpose: working capital. Three-fourths of survey respondents stated that the loan amount would be used to fund basic operations and provide the working capital necessary to fulfill orders, and produce product or services within existing businesses. The responses indicate that the businesses requesting capital are not start ups, but established businesses with capital expenditures already in place.

Small businesses are in a poor market for fundraising due to the small size of the loan. Microloans, which make up the bottom tenth of the lending pool, are those which are made in amounts of less than $1 million. Some 58% of small businesses are expected to apply for microloans as they seek new financing. Most small businesses need only a modest amount of short-term capital to finance a temporary capital deficiency. More small business owners turn to hedge funds and less than traditional sources of capital when financing becomes tight. Hedge funds have become a major lender to small business owners in the past two years as brick and mortar banking institutions exit the business.

Of the 60 percent of businesses that turned away from bank loans as a means of sourcing credit in 2011, half cited a lack of confidence that they would be approved. All signs point to falling confidence among small business owners who are traditionally turned away from banking institutions during poor economic times. Small business owners instead have to turn to less traditional forms of financing including asset-backed loans and loans backed by personal guarantees. Others turn to their home equity, financing their business with capital obtained in a loan against the home in which they live.

Businesses with lower revenues and fewer employees find it most difficult to find new sources of capital. Smaller businesses are riskier for banks, which would prefer to deal with established businesses that have more employees and safer revenue sources.

Luckily for business owners, it is possible to secure credit. While bank lending continues to deteriorate, new sources of capital continue to come online. Companies like LendingClub and Prosper, which issue peer-to-peer personal loans for individuals, are becoming major small business lenders. Alternatively, small business owners also have access to financing through government and private grants, which give business owners the chance to raise capital that never needs to be repaid.

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