Small Businesses Eye Alternative Financing

Despite budding economic improvements funding and liquidity hardships may persist in 2011, especially for small businesses. More resources, however, may be available in not so traditional places.

According to Kenneth H. Marks, a merger and acquisition advisor and founding partner of High Rock Partners, a provider of growth-transition services, research findings reveal that for every 100 small business plans that come to a venture capital firm for funding, an average of 10 get a serious look, and only one ends up being funded. “So the odds of success are 1%.”

He maintains that scarcity of small business credit makes it a challenge “to build and realistically fund” small- to middle-market companies that range from startups to several million dollar revenue shops.

Many small business lenders are also mortgage lenders now facing multiple challenges mainly due to the foreclosure crisis. In addition, the foreclosure crisis created new demand for third party services such as counseling and specialty servicing. Economic hardship and layoffs also tend to generate a new drive to pursue opportunities that lay with starting one's own small business and leverage years of mortgage expertise.

Since lack of funding may challenge especially small-size banks, thrifts and other businesses, some insiders expect to see more demand for help in the secondary market, which is facing its own challenges.

According to Laurence Kaplan, the executive vice president of Gerber Finance Inc., a firm that provides such credit options to small- and medium-sized businesses whose experience in commodities trading includes investments in the United States, Switzerland and South Africa, starting this year more of these firms will turn to alternative sources of lending including asset-backed lines of credit.

In the current economic climate it is not easy to get approved for a small business loan, says Rachel Zippwald, a California Bank Trust VP with over 23 years of experience in SBA lending. And not because “the money isn’t out there” but because small business owners “will have to work harder to get one.”

Alternative financing options, while limited, are available to those who know where to look, agrees Marks. The weak economy and more strict bank lending policies are pushing many entrepreneurs looking to start a new business who see their funding options dry up to look for more creative options.
In his view, so-called angel investors, or affluent individuals who provide financial assistance for business start-ups, represent another alternative financing option that tends to be under the radar of entrepreneurs.

According to Marks, research data show that “angel investors have been spreading their wings farther and farther.” For example, they provided funding for 24,500 ventures during the first half of 2009, compared with 23,100 in 2008.

Maybe cautiously, but consistently, more banks and other investors will enter the market to generate new lending sources to small businesses.

At present, however, research findings indicate continued hardship for small businesses, which makes insiders worry about the future.

Banking analyst Meredith Whitney told media outlets that “access to credit is being denied at an accelerating pace,” in part due to increased government restrictions on banks. She is one of many analysts who have expressed concern that more restrictions “may have the unintended consequences of curbing lending to small businesses” and hamper an economic recovery.

First Research, an industry intelligence firm, reported that while the profitability of individual banks depends on marketing skills, efficient operations, and good risk management as much as on economic activity and the level of interest rates, deep exposure to subprime mortgages and mortgage-backed securities have caused bank failures, government takeovers, and involuntary mergers.

First Research estimates the U.S. banking industry includes about 6,800 commercial banks, 1,200 savings banks and 8,000 credit unions. Their combined annual revenue is $700 billion of which commercial banks account for nearly 80% of industry revenue, savings banks 15% and credit unions 5%, where the 50 largest firms generate 70% of revenue.

Findings suggest that although the financial climate has improved, slow demand for loans and increased government regulation may result in a long recovery period for the banking industry. Yet, as a rule, smaller banks can compete successfully in segments where customer service or knowledge of the local market is more important.