In the following Q&A, Pango Financial CEO William Keenan offers insights on the cyclical nature of the lending market and advice for small business owners just starting out. Questions and answers have been edited for clarity and brevity.
Q: What’s the business climate for loans in the U.S.?
I’ve been in the business long enough to know that it runs in cycles.
Lending cycles track with economic cycles. Banks tighten up underwriting criteria in tough times, loosen it to gain market share and to grow their balance sheet as economies improve.
The big shock was really the meltdown in 2008. You overlay that with Sarbanes-Oxley — a lot of regulatory reform and the Consumer Financial Protection Bureau — and it’s put a lot of pressure on traditional lenders. They need to be extremely selective in who they lend to.
Let’s say I give you a line of credit and you’re only using 10 percent of that line. I’ve got to capitalize 100 percent of it in terms of reserves for potential losses that I have no probability of materializing because the full line hasn’t even been utilized yet.
The environment is very, very tough today compared to pre-2008.
Q: But isn’t there a reason to lend capital to small businesses? What is the upside of the relationship?
Revenue. Unlike consumer banking relationships, there is more potential fee income in a business customer relationship. They charge you monthly fees for the checking account. They’re going to charge you for wire transfers. They’ll charge account set-up fees. There’s a lot of fee income potential and it’s scalable. Even a really small business that’s generating $100,000 in revenue may involve crossover opportunities for merchant services. There’s a whole host of cross sale opportunities. It’s a sought after relationship.
Small businesses potentially become medium-size businesses. Medium-size businesses potentially become big businesses. (Banks) can end up providing you commercial loans for real estate and commercial loans for transactional finance. They can do receivable financing. For one large commercial real estate loan they may have to have 1,000 consumer customers to generate the same revenue.
The other piece is regulatory. A lot of them need to hit their CRA credits by having enough business-related transactions to satisfy that they are reinvesting in the communities.
Q: Given that, why don’t lenders make more small business loans?
The real issue is that many are geared more for the middle markets and large enterprises (and small businesses are riskier).
The co-mingling of funds and the lack of corporate governance is a regulatory risk and the legal risk. For instance, if you go to Costco, you have a lot of people who are co-mingling (business and personal products) in their baskets. All that makes lenders nervous. A lot of small businesses don’t have the infrastructure to mitigate risks to the comfort of traditional large banks.
Q: So if the credit market is difficult how does an individual get money to start a business?
The only way around is to have a well-capitalized business. And that typically is going to be that individual investing capital any way they can find it.
Some people who are just starting out try to finance their businesses by making poor credit decisions. They apply for multiple credit cards and use those cards to help provide liquidity to their business.
Many will use retirement funds and will pay the penalty and the tax for early withdrawal.
Q: Are there better ways to get funding in this market?
The federal government is trying promote additional liquidity for the small business segment through Small Business Administration-backed loans which provide a credit backstop for those lenders.
The SBA is a good route. But you still have to come up with some equity.
Q: What about emerging lending markets for small businesses?
There are all kinds of financing products. Really the challenge is how the purchaser’s financial acumen is best utilized to get the right mix of access to credit rather than going out and paying 21 percent interest.
There are a lot of new entrants. You have Biz2Credit. You have Kabbage, which does receivables financing. You have all these emerging marketplace lenders that originally were just going direct to consumer, where it’s very expensive to create a brand awareness and advertise.
Now they’re forming partnerships with traditional banks (which have) legacy systems. When you go into their platforms and apply for a loan, you’re really being driven into some of the marketplace lenders’ platforms.
Q: What about your product?
Our Dreamspark product enables people to access their own capital by way of their retirement funds without paying a penalty or tax for the early withdrawal. Essentially, it permits you to invest in your own business.
Q: What happens if that business fails?
You’d lose your shares.
Q: How should business startups weigh different financing options?
Let’s face it, equity is the most expensive form of financing because you’re giving up a share of all future cash flow in the enterprise. If somebody with $100,000 earns 10 percent profit each year, that would be a 10 percent return. But if they capitalized with $50,000 and borrowed another $50,000, and still earned 10 percent, they would actually be getting a 20 percent return on that capital.
But there are major success stories of people who had no money at all and started a company by maxing out their credit cards. At the end of the day it’s all about education and checking one’s ego at the door.
Q: What advice do you have for people who are just starting out.
An individual who wants to be an entrepreneur needs to put on a business person’s hat and look at that business and at forecasts.
Think through the market that you want to serve or the product that you can create. Then think about everything that can possibly go wrong, down to developing your name and whether or not someone else has it. What legal advice are you getting? It’s really thinking through your business plan, then starting a legal entity.
Think about your business structure. Then have a clean piece of paper and say, how am I going to finance this? Do you already have a customer?
Educate yourself. Look at all the various options. Layer the cost of credit and your ability to service that credit into your business model. How much equity do you have to scrounge up to mitigate your financing costs? That should help direct your options and what kind of business you end up starting.
If you’re opening up a small restaurant, or café, you can’t anticipate demand with certainty. You need to achieve an allowable funding cost. It may dictate that it has to be no more than a 7 percent interest rate. That’s pretty much going to mandate that you get a conventional loan with significant equity.
Q: Where should businesses start their research?
It depends on what business you’re in and what you want to start. If it’s a restaurant, do mother-in-law research. Speak with the manager of your local McDonald’s or Burger King or Subway and learn about all the trials and tribulations. Then (research) location. Do you have enough traffic?
Then there’s the Chamber of Commerce. There also are state programs.
Q: Why do so many businesses fail?
A lot of businesses fail because they have an idea and they just jump into it without doing their homework. For those who have a good idea and have done their homework it increases their ability to succeed.
Q: How do you surround yourself with good, resourceful people?
You can go online and Google marketplace lenders and small-business lenders. You should talk to your local community bank. Even if you’re turned down, they’re a great source of information. Ask what would it take for me to be approved? How come you’re not approving me? If you’re not going to approve me for a working capital loan, will you finance my receivables?
The individual has to reach out. Entrepreneurs who have been really successful see an opportunity in the market and look at their competitors. They have conversations and learn everything they can about what they’re doing and how they’re doing it and how they make money.
About Janet Kornblum: Janet Kornblum is an award-winning journalist, writer and the co-founder of Panic Media Training, where people learn how to deal journalists such as herself. Her work has appeared in USA Today, CNET, Salon, Reuters and many other publications. You can find her in all the usual online places, including Facebook,Twitter and her site.