Data from the Small Business Administration indicates that of all U.S. employer firms operating in 2010, 99.7% were small businesses. However, the definition of “small business” is wide reaching and includes everything from basic home-based, non-employer scenarios to complex firms with commercial operations and hundreds of employees. Among even the smaller businesses, though, there’s an important subcategory to which nine out of 10 firms operating today belong: microbusinesses.
Microbusinesses typically require $35,000 or less in capital to get started, may operate out of a home, mobile location, or other less-traditional workspace, and normally have five or fewer employees. But despite their overwhelming prevalence, most mainstream lenders overlook these businesses. According to the Institute for Local Self Reliance, microloan volume — defined as $100,000 or less — fell 33% at U.S. banks from 2000 to 2012 and small business loans dropped 14%. Conversely, large business loans rose 36% during the same period.
This disparity represents a missed opportunity for financial institutions. Microbusinesses might carry additional risk, but the unmet, growing need in this demographic is something no community-oriented organization should gloss over lightly, and the following three tips will help credit unions better evaluate microbusinesses to determine the risk inherent in each loan request.
Keep An Open Mind
Although the high aggregate failure rate of small businesses is frequently publicized, factors such as years in business, business model, location, and more alter risk projections substantially.
For example, approximately 50% of new firms close within their first four years, but survival rates trend upward from there, according to the SBA. According to Forbes, 62% of microbusinesses report earning $100,000 or less annually with a growing number of non-employer and sole proprietor firms earning six or seven figures. Although a steady stream of income might not guarantee survival, it does indicate a business is offering the right services in the right place and time, and knowing the market like that impacts long-term viability and stability.
Before making, or denying, a microloan, credit unions should also consider the difference between temporary business shortcomings — such as setbacks from the recession or medical issues with the owner — and persistent issues that will continue into the future.
Concerns surrounding how socio-economic challenges and other widespread factors sway calculations for creditworthiness have led the SBA to develop a new predictive scoring method that combines the credit score of both owner and business into one unified metric. This is a valuable resource for SBA lenders — who no longer face the requirement of analyzing a business’s cash flow — as well as a reminder for all lenders to look at the big picture to see the full potential of each lending situation.
Build The Ideal Borrower
The short-term concerns and daily burdens of running a business are demanding. So much so that it's not unusual for owners to develop tunnel vision and neglect to hone their operational and financial skillsets beyond what they started with.
Unfortunately, the ability of lenders to coach these individuals — much less finance them — only extends so far. That’s where incubators, community action organizations, and other third parties come in. These lending partners can not only share the educational burden but also foster a steady pipeline of vetted, mature loan opportunities.
Redwood Credit Union ($2.4B, Santa Rosa, CA) started its business lending program in the mid-2000s, says Michael Downey, senior vice president of business services. Today, approximately $20 million of its roughly $245 million total MBL portfolio consists of small business loans of $50,000 or less. Its average small business loan hovers around $35,000, but the credit union also makes loans of as little as a few thousand dollars.
“Underserved and emerging microbusiness was a group we wanted to reach out to and provide financing for since the beginning,” Downey says. “Most people start a business because they’re good at something, but that might not always be finance. As a result, many of these borrowers need additional educational resources to better understand things like their business plan, income statement, and cash flow.”
In 2013, the credit union joined forces with the Community Action Partnership of Sonoma County to offer up to $1 million in loans to graduates who complete the organization’s intensive 18-week incubator and financial education program and are referred to Redwood by their instructors.
“This was a natural alignment and a great first step for this market,” Downey says. “Without that educational component as a risk mitigant, we might not be able to do these loans.”
Adopt A Microbusiness Mindset
Most, if not all, credit unions already have a host of microbusiness owners within their membership, but being able to identify and serve them is another matter. Microbusiness owners who feel shut out or overlooked by a credit union’s business services department are likely to take one of two actions:
They’ll squeak by using consumer–level financial tools that are ill-suited for their needs. This often leads to issues for both parties down the line.
They’ll abandon ship altogether in favor of outside assistance, typically offered at a premium.
Credit unions who do serve their microbusiness members effectively tend to offer a middle ground that falls somewhere between the complex products and services used by commercial clients and the basic offerings used by consumers.
For example, Vystar Credit Union ($5.2B, Jacksonville, FL) offers a microbusiness starter credit card with limits as low as a $500. At Consumers Credit Union ($517.7M, Oshtemo, MI) business owners looking for a loan of $50,000 or less can fill out an express version of the credit union’s standard MBL loan application. The form eliminates the need to provide three years of personal tax returns, business tax returns, and sophisticated business documentation like profit and loss statements. The truncated application allows borrowers to purchase necessities such as equipment and vehicle loans that microbusinesses would most likely be pursuing.