The ability to access capital is essential for ensuring the financial health and stability of a business. However, many businesses, particularly small businesses, discover that accessing capital is not easy due to many bankers’ reluctance to extend sufficient credit access or capital. Without access to capital, many small businesses suffer cash-flow related problems preventing either expansion or sustainability of the business. The following four reasons indicate why businesses have difficulty in accessing capital:
1. Poor Business Credit Score
Most people are aware of the negative consequences related to having a poor credit score such as having to pay a higher interest rates on various types of loans and credit cards balances. In fact, someone with a sub-550 credit score may find it difficult to get any loan at all from a reputable lending institution. In a similar manner, businesses that have a low FICO SBSS business score will have difficulty in securing capital in the form of loans and lines of credit. The FICO SBSS score is used by banks to rank businesses on their ability to make on-time payments.
2. Inadequate Cash Flow
After the “dot-com” bust of 1999-2001 followed by the real estate crash of 2007-2009, banks have become very cautious about lending to businesses that do not exhibit strong, positive cash flow. Before allowing a business access to capital, banks verify that the business has sufficient cash flow to cover both the monthly loan payments and normal operational expenses such as payroll, property and inventory costs. If lenders decide that a business is a default risk because of an inadequate cash flow, then access to capital will be difficult to come by.
3. Bank’s Risk-Adverse Behavior
Whereas large corporations have little difficulty in accessing capital, banks restrict access to capital for small businesses since these businesses have significantly higher rates. Since the Great Recession, banks have tightened lending standards restricting many businesses from accessing capital. As seen in the previous recession, small businesses are particularly sensitive to a cyclical economic downturn so lenders factor in the likelihood of default when considering allowing access to capital. Higher interest rates on loans and increased collateral requirements are but a few of the requirements leveraged on small businesses as a result.
4. Fixed Costs for Small Loans
There are fixed costs associated with any loan or access to a line of credit such as an underwriting fee, loan origination fee and processing fee. As a result of these fixed costs, it is more expensive for banks or other lenders to extend capital access to small businesses. Lenders make significantly more profit on a $2,500,000 loan than a $25,000 loan leading them to focus more on providing loans to larger companies at the expense of smaller businesses. Furthermore, since small businesses tend to have little publicly available information, evaluating the overall financial condition of a small business often is an expensive proposition. In such a situation, lenders choose to forgo extending access to capital to avoid incurring the greater cost and risk associated with these loans.
In today’s business climate, accessing capital is a challenging task for many businesses, but Camino Financial is determined to provide a solution. Read September’s Community Letter: No Business Left Behind!, where we announced the test and launch of our new product and determination to provide capital for small businesses.