Banks are loosening up and approving more loans to small businesses these days, or so they say.
Yet many small businesses that are unable to obtain financing from a traditional bank would argue not much has changed.
As many commercial banks scoured for cover in response to the Great Recession and pulled back from lending to anyone but their best clients, other sources of capital emerged to fill the gap.
Except for the crowdfunding and peer-to-peer websites that are relatively new, many of these alternative sources have been lending for years.
The nonbank sources include mezzanine debt financiers, life insurance companies, credit unions, venture debt lenders and asset-based financing companies such as factors.
At the very end of the cost spectrum are credit cards, payday lenders and hard money lenders.
Most financial sources say banks aren’t adverse to making loans to small businesses and are always seeking qualified customers, but that they are operating under much stricter lending guidelines that took effect following the financial meltdown some six years ago.
Steve Sefton, president of San Diego’s Regents Bank, a subsidiary of Grandpoint Bank in Los Angeles, said in some cases the new regulations have stymied lending money to borrowers who would have been approved several years ago.
“The bank regulators are getting in the way of the people they are supposed to be protecting,” Sefton said.
Here is a look at what some alternative lenders are.
Mezzanine debt lenders
These lenders usually provide term loans to help businesses expand, buy other businesses or refinance existing debt.
Tim Bubnack, managing partner of San Diego-based private equity firm Huntington Capital, said it provides debt and structured debt equity to generally established companies with annual revenue of $5 million to $75 million.
“The majority of the deals we do are mezzanine loans that are subordinated to senior lenders such as banks,” Bubnack said. “We’re like a second [mortgage] on your house, and below the senior bank.”
The firm’s “sweet spot” is in loans ranging from $2 million to $5 million. While banks usually require pledging of collateral for approval, Huntington focuses on a business’s cash flow.
Terms are usually five years, but can be structured as interest-only for several years with balloon payments at the end. Rates usually range from 11 to 13 percent and usually include some participation in the company’s future upside through warrant agreements. Warrants are options to buy stock in a business at specified prices.
As debt holders, companies such as Huntington are in a stronger position than pure equity investors such as venture capital firms in the event a business fails, Bubnack said.
But like most VCs, these lenders also take a seat on a company’s board to ensure things are working well, Bubnack said.
“We are proactive investors in the value creation process,” he said. “But we’re noncontrolling investors.”
Insurance Companies
Just like pension plans, insurance companies have been longtime lenders on commercial real estate because they need to match their long-term liabilities to assets like 20- to 40-year mortgages, said Jeff Hudson, CEO for George Elkins Mortgage Banking Co. in Los Angeles.
Hudson, and other mortgage banks like his, act as correspondents to life insurance firms, assembling all the data, underwriting the loan and servicing it once the insurer approves it.
In many cases, the small business borrowers are buying the buildings they operate from and can obtain a better interest rate and terms than they might get from a bank on an SBA loan, which include rates that adjust every five years, he said.
An advantage to SBA loans is these can go up as high as 80 percent of the property’s value while insurance companies rarely go above 70 percent loan to value, Hudson said.
However, the insurers have more latitude to get a loan approved than banks, he said.
“Life companies are focused on the value of the asset, and then they check on the credit of the borrower to make sure there’s no fatal flaw,” Hudson said. “The banks evaluate the credit of the borrower first and then back into the value of the asset.”
Credit Unions
Despite their reputation as lenders of only consumer loans such as auto and credit cards, credit unions have been increasing lending to small businesses in recent years.
In California, credit unions’ total loans increased 6.3 percent last year with business loans increasing 5.4 percent over the year, according to the California Credit Union League.
Jeff Stone, chief credit officer for North Island Credit Union, said the most common type of business loans North Island makes are mortgages on owner-occupied buildings, lines of credit and equipment financing.
Most of the loans fall into the $4 million-to-$5 million range and carry fixed rates that reset after five years.
Credit unions, like banks, can also share or participate with other credit unions to make larger loans. Stone said the largest business loan NICU has made to date was about $18 million.
Venture Debt Financing
For startups that are able to secure venture capital, there are options to obtain loans based on their cash flow.
Wade Hansen, CEO of Cabrillo Advisors, a San Diego broker-dealer on for-sale businesses, said his firm also helps arrange loans that either come with additional surrender of equity or straight term loans, usually for no longer than two years.
“The companies we’re working with are typically looking to borrow about $5 million to $10 million on the low end,” Hansen said.
The businesses are usually at least three years old and have either intellectual property or receivables to pledge, he said.
Hansen wouldn’t say what the interest rates are for such loans, except that investors who provide the funding seek a return on their investment of at least 10 percent, which means the rate will be above that.
Asset-Based Lenders
If a business has sales and sufficient receivables, it can borrow money from asset-based lenders that are sometimes called finance companies.
As the name implies, the lenders provide funding based strictly on the value of the assets a business pledges.
When it comes to lending on property, the terms and rates vary but expect to pay at least double digits these days.
Factors are another type of asset-based lending that entails a business selling an accounts receivable contract that has already delivered the product or service.
The company getting the cash sells that contract, paying a fee for the money ranging from 2 to 4 percent of the total contract, depending on how long the client’s customers take to pay.
“Essentially we’re buying invoices of work that’s already been completed at a discount,” said Jason Severson, president of Primary Funding, a Miramar-based factor.
That fee the business pays for the money translates to an annualized interest rate ranging from 18 to 36 percent, he said.
Among the most common users of factors are temporary staffing companies, apparel makers, manufacturers and distributors, and transportation companies, Severson said.
Merchant Cash Advance
Cash advance providers may be an option for businesses that need money and have exhausted all other alternatives because this one is quite costly.
The providers advance funds to the business based on their last three to six months credit card activity.
The unsecured loans come with hefty fees and are usually repaid on a daily basis, with the lender taking a specified percentage of credit card sales.
Common users for this type of high-rate financing are restaurants, service companies and retailers.
The cost for this money is often well above 30 percent annually, and can go above 100 percent.