Banks Don't Like Small Business Loans
Written by CMG News Contributor, Doug Carleton
Not today, not yesterday, not tomorrow. These loans include start-ups as well as many early-stage companies. There is no specific definition of early-stage, but a general definition would be a company that is less than two years old. The reason for banks' general reluctance to lend to young companies is that the likelihood of failure of a company generally occurs during the first two years. Most big banks consider start-ups to be any company that is less than two years old.
The most recent estimates from Fundera, a major online business funding matchmaker (similar to a loan broker), reflect that the average small business borrows less than $40,000, which's primarily for working capital. Many of the loans are considerably smaller than that. These are not the types of loans that banks like - and very seldom make - which is why the PPP programs, with all of their complications and complexities, have distributed over $686 billion as of early March. Many of these loans have been well under $40,000, and the vast majority have been for things that are normally considered working capital. Two of the major reasons that banks don't like small business lending are 1) It takes almost as much effort to underwrite a $25,000 loan as it does a $250,000 loan and; 2) Banks make very little money on small loans given what it costs to make them. Banks have not been aggressive adopters of technologies that can speed up the loan underwriting process. Currently, an application has to be completed and submitted along with supporting documents. A banker receives the application and reviews it for completeness, including the necessary documentation. Once reviewed, the application goes to a credit underwriter. If the underwriter approves the request, it may have to go to the loan committee. Assuming the loan request survives that gauntlet, the approved application goes to the closing department for paperwork preparation, the closing of the loan, and the disbursement of the funds. That is four separate touches on one loan application.
The pandemic has done tremendous damage to thousands of small businesses. Thousands of businesses have made it through but in many cases, their sales and profits have declined. For some of them, substantially. Declining sales and profits give bankers the vapors. There are also thousands of new businesses launching, but they are starting in a challenging bank lending environment. After the Great Recession of 2007-2009, it took nearly five years for banks to get back to pre-recession levels of small business lending. And... here we go again. The reasons for the difficulties that many small businesses face today are different from the last time. Previously, banks were suffering mightily from bad real estate loans and regulators forcing them to put aside large amounts of capital to cover potential loan losses. We are currently in a different environment, and banks are generally in strong financial shape. But, bankers have long memories.
None of this means that banks aren't or won't be lending to small businesses. However, because of the pandemic and the fact that the economy is still nowhere back to full strength or employment levels, small business loans are under very tight scrutiny. Credit scores may have to be higher, and larger cash injections may be required, to cite two examples. Interest rates are at historic lows, so it is a good time to borrow if necessary. Just be aware that it will not be easy.
This blog entry is a slightly edited excerpt from Doug Carleton's 'The Daily Life Of A Small Business Owner' series. Doug was a mentor with SCORE, Startup Virginia, and Lighthouse Labs, and has 25+ years of experience in small business finance including 12 years in SBA lending. To contact Doug directly, please email him at firstname.lastname@example.org.