Learn how to – Where do small businesses take financing?

Learn how to – Where do small businesses take financing?.

Money from the bank

The first answer that comes to an entrepreneur’s mind when looking for financing is to take a loan from a bank. Today I will tell you about all the nuances that I know, and with the help of the Credit Card Payoff Calculator I have calculated the approximate cost and benefit of obtaining a loan from various financial institutions. Enjoy watching!

According to the bank, as of August 2021, small businesses (annual income up to $50K) had received $72.6 billion in loans from banks, which is almost 10% of all loans to businesses. But this amount is not even close to $33 billion, about which the IFC writes, although from year to year the National Bank talks about the excess liquidity in the banks’ accounts.

Besides, credits, given by banks, are often loans for replenishment of current assets and refinancing of the existing borrowers, but not long-term financing for development. Under the same state program “Affordable Loans 5-7-9%” from February 1, 2020 to October 4, 2021, issued loans worth $ 64.8 billion. But only 12.5% of these funds were issued for investment needs.

In addition, the bank lends at the expense of depositors of deposits. Hence the strict requirements of the National Bank to the institutions themselves, and therefore the banks’ requirements to the borrowers – all in order to minimize the risk of default on the loan. Not every small enterprise can meet all the requirements to get financing from banks. For example, information disclosure requirements. 

KPMG notes that SMEs often work covertly to optimize costs and do not want to hire an accountant to prepare transparent accounting. Many individual entrepreneurs also prefer not to show the real level of turnovers and income, fearing that the bank will transfer information to regulatory bodies. While banks in making decisions on the granting of credit rely only on official statements.

The level of loans attracted from banks for business development is extremely low 

“When an entrepreneur comes to the bank for money for development (even having real estate as collateral!), the Bank will not always give him a loan because, in accordance with Federal Reserve requirements, the entrepreneur must show a business plan, existing and projected revenue from the business, and they must” necessarily cover the payments, “- says the managing partner of a leasing company.

The problem is even more pronounced for new businesses looking for ways to raise startup financing

“The problem of finding startup capital for entrepreneurs is very painful,” says Emily Evans, project leader at StartUp USA. For tech startups it’s still possible to raise money from a startup fund, but for agribusiness and manufacturing startups, or cafes, finding money is very difficult, she says. 

“The only way is to borrow from yourself (if you have savings), friends, family, or ‘fools’. That is, from all those who are willing to support and risk. Right now, those are the only solutions that exist,” says Emily Evans.

“When starting a new business – selling the March & Co. pastry shop – we went to the bank for a loan. We were buying equipment, and we wanted to finance 70% of its cost with bank money. The bank, which beautifully advertised its support of small business, “tormented” us for 4 months, requiring more and more new documents. In the end, when the equipment was already in stock, and it was critically necessary to take it away, we were refused. And this despite the fact that I acted as a guarantor for the loan, and the assets in government bonds alone were enough to cover the loan amount,” – says Martin Gilbert, partner of the consulting agency iPlan and founder of the social project “Family Budget”.

The situation can be partially improved with the help of SME assistance programs of state and international funds. Depending on the conditions, they reduce the risk for banks, and then they are more willing to lend to SMEs. For socially responsible businesses there are possibilities to attract grant funds within the framework of international association support programs. For example, from the very beginning of its activities in 1996, the Entrepreneurship Development Fund (until February 2020, the German-Ukrainian Fund) supports the financing of micro, small and medium businesses to improve their competitiveness.But in general, even financing attracted by special programs requires a certain level of transparency and preparedness from businesses. What about businesses that don’t “qualify” for such requirements?

What about non-banks?

The next option is non-bank financial institutions. The main advantage of such institutions is that almost all of them (with the exception of credit unions) do not risk depositors’ money. That is why the requirements of the regulator for them are softer, and thus the requirements for the borrower are easier to meet. According to the NBU, 969 financial companies, 318 credit unions and 301 pawn shops (a total of 2079 financial institutions, including banks and leasing companies) were operating at the beginning of 2021. But the vast majority of these institutions work with individuals rather than businesses, and each category has its own specifics of cooperation. 

For example, the cost of credit in MFIs can reach 1000% per annum. This is a painful situation for society, because such conditions do not allow the entrepreneur to make a profit. In addition, financial companies are known for their propensity to intimidate borrowers and resort to uncivilized methods of coercion to repay the loan, although the regulator has recently begun to punish such practices with fines. A pawn shop loan can also be a painful “bite,” according to the Federal Reserve Board, the weighted average annual interest rate in 2019 at a pawn shop was 215.2 percent. In addition, it is impossible to obtain funds without the physical transfer of the collateral, and if the borrower does not repay the loan, the pawnshop may seize other property of the entrepreneur.