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Chapter 5

Think Small: Microloans, CDFI’s and Credit Unions

Carlos was recovering from spinal surgery. When it became clear that he couldn’t return to being a painting contractor, he needed to find another career. After reminiscing about food trucks at a party, Carlos and his wife Maria drew up plans for a ‘tricked out’ truck with pin striping and a rockin’ stereo system. They took their plan to a regular bank, but didn’t get very far. In fact, the bank didn’t get it and told Carlos and Maria that they were too much of a risk.

They were referred to a non-bank micro-lender by a friend. When Maria and Carlos presented their idea to the micro lender they got it and loaned the couple $35,000. “They didn’t laugh,” said Maria. “They went all the way with us which was so cool. During the first year, we called our rep. ‘We are struggling, and we don’t know what to do’ and they were always supportive. We wouldn’t still be here without our lender in that first year.”

Carlos and Maria specialize in Tex/Mex food and they cater corporate events and street festivals. They became so successful that they went to CDC Small Business Finance for a bigger loan to pay off the first loan and buy another truck. They now have three trucks and are looking at a fourth, have two employees besides themselves and hire lots of independent contractors.

For many banks, especially regional or national ones, a very small loan to a very small business simply isn’t profitable. However, one of these loans—often dubbed “microloans”— can make or break a new venture. That’s where microlending organizations come in.

Usually, things that would be problematic in traditional loans—a bad credit history or lack of collateral, for example—aren’t necessarily strikes with microlenders, who not only provide loans of up to $50,000 but will also provide training and mentoring to borrowers. If you want microloan funds, you must be prepared to fulfill their training and planning requirements before they’ll even consider your application.

Microloan program loans are offered to small business concerns and certain not-for-profit childcare centers. Designed for survival-mode businesses, microloans aren’t intended for paying existing debts or purchasing real estate. They may be used for the following:

• Working capital

• Purchase of inventory and supplies

• Purchase of furniture and fixtures

• Purchase of machinery and equipment

Because of the terms and amounts of microloans, SBA microloans come with a shorter term and higher interest rates. The maximum length is six years, and rates range from 8–13 percent.

Microlending at Work

CAMEO, the California Association for Micro Enterprise Opportunity, demonstrates the power of microlending. According to Claudia Viek, their CEO, CAMEO has been creating jobs since its inception in 1993 by helping people to be their own boss or, in other words, to create their own job. Their mission is to grow a healthy, vibrant, thriving environment for all entrepreneurs and start-up businesses by advancing the work of their statewide member network.

Cameo’s 85 member organizations provide the entire spectrum of entrepreneurs with small and micro-business financing, technical assistance and business management training. In 2013, CAMEO members served 15,000 very small businesses that supported or created thousands of new jobs in California and generated over a billion dollars in economic activity. This success is possible because members offer a rich continuum of business services. Research in this field shows that businesses that receive assistance have an 80% success rate as compared with the 50% to 80% mortality rate for small businesses overall.

In other words, they don’t just make loans. They help businesses succeed.

As California’s statewide Micro Enterprise association, CAMEO expands resources and builds the capacity of member organizations. For example, CAMEO works with corporations and government to leverage new capital and grants. Wells Fargo, Chase Bank and even Chevron have made significant new investments and grants to microlenders. However, achieving scale in microlending has significant barriers. Operating costs are high due to a small capital base and the extra expense of providing technical and business assistance. CAMEO has put in place innovative online platforms to scale up microlending in California. Because lending requires volume the platforms reduce operating costs and facilitate small business capital.

Not every state has a microlending organization like CAMEO. For more information on them visit www.microbiz.org. But there are micro lenders out there, as we will discuss.

The Landscape of Microlending

A recent opinion poll by Small Business Majority, Main Street Alliance and the American Sustainable Business Council found that “90 percent of small business owners believe the availability of credit is a problem, and three in five say it is harder to get a loan now than it was four years ago.” The larger banks have pulled back on loans under $250,000. The problem is the small loans cost about the same in transaction costs as a $1 million loan. So if traditional banks aren’t lending where can small businesses find funding to run their businesses and help with cash flow?

The answer is to look for alternative lending sources, such as microlenders and community development financial institutions (CDFIs), including community development credit unions.

Microlenders/CDFIs often make loans under $50,000. These loans include those financed by the Small Business Administration Micro Loan Fund, USDA Rural Development loans and community development loans by local governments, banks and donors. Microlenders place more emphasis on cash flow than collateral, and give more weight to the character of the borrower.

Community Development Financial Institutions

If you’ve been in a Starbucks in recent years, you may have seen red, white and blue bracelets offered for a donation of $5 or more to the Jobs for USA campaign. Starbucks joined forces with Opportunity Finance Network, a network of Community Development Financial Institutions (CDFIs), to help raise money for loans to small businesses and seeded this campaign with a $5 million donation.

If you donated to the campaign, as the authors of this book did, you may not have entirely understood what you were supporting. In fact, it’s possible that this campaign could become a source of funding for your business, or that of someone in your community.

CDFIs include non-profit loan funds, credit unions, banks and venture funds that focus on making loans to underserved communities. In addition to making personal loans, they are often a crucial source of funding for small businesses that have been turned down for loans from traditional sources. CDFIs may provide funding for small businesses, microenterprises, nonprofit organizations, commercial real estate, and affordable housing.

The group that Starbucks partnered with, Opportunity Finance Network, has originated more than $30 billion in funding in urban, rural and Native communities. In particular, CDFIs often focus on low-income and/or minority communities, though applicants shouldn’t be discouraged from reaching out to one if they are having trouble getting funding and don’t meet any of those criteria.

If you apply for a loan through a CDFI, you should expect that the lender will run a personal credit check on you, the owner. It’s likely that your credit score will be considered in the application process; but it’s usually only one part of the decision and most CDFIs will tell you that even with past credit problems you may still be eligible for loans. In addition, CDFIs may be able to consider non-traditional credit references, such as rent or utility payments, for example.

Typically, these loans require collateral and/or personal guarantees as well.

CDFI’s offer loans of varying sizes including microloans as well as some that go as high as $250,000. Many CDFIs provide small-business coaching and other professional resources, such as legal, accounting, and marketing assistance, to grow their borrowers’ small businesses. CDFIs usually:

• have more flexibility with their collateral and credit requirements (they accept good, but not perfect credit)

• are willing to consider explanations for lower credit score (such as loss of home equity, late pays, illness)

• consider the character of the borrower

• offer reasonable loan terms and try to make sure the borrower thoroughly understands them

However, businesses still need to show the ability to pay back the loan through positive cash flows and have a marketing plan to guide growth. The loan criteria is often listed on the lender’s website and vary in terms of a business location, loan size, interest rates, risk, or borrower income.

CDFI’s want to “make loans that change lives,” says Mark Pinskey, President and CEO of Opportunity Finance Network.

Finding Microlenders

The first real step is to research alternative lenders in your area or those that lend online without regard to geographical location. Look for an established government agency or nonprofit, such as Community Development Financial Institutions and credit unions. Some city and county governments run microloan programs. Talk with your local economic development or business development agency. Other good sources for loans referrals are Small Business Development Centers and micro enterprise development organizations. While most of them don’t lend money, they are often connected to the capital resources in their communities. (See lending and business resources in the Resource Section.) Opportunity Finance Network also maintains a free locator service for member programs on its website.

The second step to finding a small or micro-business loan is to make sure that you are loan-ready, i.e. that you meet the criteria. That means that you have satisfactory answers to the following:

• What is the purpose of the loan?

• How the loan will be repaid?

• What is Plan B for repayment?

• Do you have a business plan?

• Do you have financial statements? (Cash flow and P & Ls)

• What is your collateral?

If you don’t meet the criteria, then seek out help from a local entrepreneurial training provider. Not only will they help a business obtain a loan, but they will help locally grown small and micro-businesses become successful.

Finally, be prepared to give the lender what they ask for. Entrepreneurial training organizations often can help you with loan packaging, such as putting your documents in order and making sure the lender has all the information that they need to consider your loan application.

Credit Union Loans

Credit unions may not be the first place you think of when you think of small business loans, but don’t overlook them. Many credit unions make loans to small businesses in their community, and during the economic downturn, some were making loans to businesses that were being turned down by other financial institutions. In addition, some credit unions offer smaller loans than some banks, and usually have very close ties to the communities in which they live and work. Some strive to lend to underserved or overlooked businesses. That makes credit unions one of the first places you may want to consider for a loan for your business.

Find out which credit unions you may be able to join at www.ASmarterChoice.org.

How to impress the lender and get the loan

A lot of borrowers are unaware of what it takes to get a business loan. They think that if they have been a regular customer of that bank, the bank should give them a loan; or if they show up with a passion about their business, the bankers will share that enthusiasm.

You will make a great impression if you know what the lender wants. We covered some of these points in the previous section on bank loans, but they are crucial so they bear repeating. Commonly, a lender is looking for the following:

• Cash Flow and Profits: Business tax returns that show two years of profitable operating history, or enough historical profits to cover your personal expenses and make a loan payment.

• Bank Accounts: Bank statements that show well-managed personal and business checking accounts—that is, no overdraft, transfers between accounts that follow sound business practices and healthy balances for business operations and household expenses.

• Credit History: Good credit history with no defaults or bankruptcies.

• Collateral: Equity in real estate, large equipment or vehicles.

• Equity: Business owner has 25% of total project costs in cash or direct investment to contribute to the project.

• Uses of funds: Funds needed to expand or evolve an already successful business.

• Industry Experience, Planning and Research: A solid business plan based on industry standards.

• Supporting Documentation: Location, job creation potential, type of business and any information that enhances the business’s chances for success.

If a borrower has all of the above, they will be considered low risk and have more loan options. When one or more of the above is shaky, such as a history of overdrafts, unexplained deposits and transfers in the bank accounts, the funds are needed for business start-up or refinancing, or the business owner has little or no industry experience, then the loan application is considered to have more risk.

In the end, microlenders will go beyond what traditional banks would do in terms of risk and will be more flexible in the loan criteria. But they still have criteria. They still want to see cash flow, good management on checking accounts, some type of collateral and proof that you know your industry and how to generate revenue.

Now let’s consider whether it is a good idea to use your retirement monies…