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  • Small Business Finance: Will Traditional Lenders Return?

    As banks and other traditional small business lenders repaired their balance sheets and licked their wounds following the credit crisis of 2008, small business lending nearly dried up. In order to satisfy regulators, banks were not in a position to make loans, especially to small businesses without an SBA guaranty. Part of the recent growth in the MCA sector coincides with these traditional small business lenders exiting this sector. This article will focus on the impact to the MCA industry if and when banks do start lending again to small businesses.

    I will preface the answer to that question with three initial responses. First, I donít expect traditional small business lenders to return to small business lending anytime soon. Second, many of the merchants seeking an MCA will have a difficult time ever being bankable and third, in the event banks return to small business lending it will not necessarily be bad for the MCA sector.
    It is no secret, that across the board, banks have tightened their credit policies since 2008. In the wake of the credit crisis and near collapse of some of the largest financial institutions in the U.S., the government and bank regulators have focused on protecting the FDIC insured assets of banks through a combination of strategies that included the following:

    1. TARP and other similar programs helped banks build up their balance sheets;
    2. Regulators stepped in to protect depositors of failing banks; and
    3. Crack down on the loose credit policies that contributed to the crash.


    As a result of tightened credit policies, lending volumes decreased significantly since 2008, especially for small businesses. Banks who made money primarily through loans have increasingly focused on fee income to supplement the decrease in loan revenue. In the five years since the credit crisis, banks have slowly started lending again to borrowers who are at the top of the food chain. Unfortunately for small businesses, most are not at the top of the food chain, so in order for a small business to get a loan from a bank, it basically has to qualify for an SBA loan or the loan would be declined. In the case of an SBA guaranteed loan, the bank is also underwriting the SBA guaranty as well as the underlying business and this SBA guaranty is mitigating the risk to the bank.

    Sadly, many small businesses donít neatly fit into the SBAís lending box. Those that do fit in the box donít always have the luxury of the 90-120 days it will take to see whether they qualify. Banks have also been helped by artificially low rates from the Federal Reserve and they been able to maintain spreads on the loans that they are making. At some point banks will begin to start chasing yield and then lending across multiple spectrums will increase based on looser credit policies. Eventually some small businesses that are currently seeking premium merchant advance programs may in fact qualify for a traditional loan. That being said, I donít see this happening anytime soon and small businesses will be the last borrowers to see traditional lending return, so we should have a good runway as direct MCA providers.

    Even if banks return to more robust lending practices, many merchants are simply not bankable. In addition to poor credit, weak financial statements, liens and judgments, the typical MCA merchant has an acute need for capital and the urgency of the transaction prompts the merchant to pursue an alternative financing source. The speed of execution and certainty of closing are the driving forces behind a small business seeking a merchant cash advance. In addition, the size of the transaction prohibits the small business from seeking more traditional financing. Banks and other large financial institutions simply donít want to do loans under $100K. Based on these factors and others, I donít think banks becoming more active in the small business sector will have a significant negative impact on the MCA space.

    With all that said, what would happen if banks do start lending to a large segment of small business? To answer that, I will draw a parallel to my previous experience as a short-term real estate lender. Prior to founding RetailCapital, I was a partner in a fund that provided 1 to 2 year real estate bridge loans. Bridge lending is a more mature industry, so perhaps there are some lessons to be learned for MCA providers. Both industries focus on achieving strong risk adjusted returns by providing capital to borrowers or merchants who donít have access to traditional capital sources and who typically have an urgent need for capital.

    What I learned from my 15-year career in real estate is that there is always a need for this type of capital regardless of what the macro-economic conditions are or whether there are more competitively priced options available. In the early part of the last decade, there was a lot of capital available for all types of real estate deals and to achieve our desired yields, we focused on acquisition and development loans (ďA&D LoansĒ). These loans were higher up the risk curve, but the risk was mitigated in that sector by having a more certain exit strategy. Our typical A&D Loan was paid off by a construction loan.

    While our deals were higher up the risk curve because the conventional lenders were competing for the lower risk deals, we were able to achieve very strong risk adjusted returns because we had an exit strategy. When traditional financing sources stopped lending in the mid to late 2000s, we were able to achieve the same kind of yields on more conservative deals, but the risk was increased because there was no clear exit to our loan.

    Could this actually apply to the MCA industry? Would we, as MCA companies, do more business if there were a traditional exit to our advance? Today, advances pay off out of cash flow, get renewed or get paid off by one of our competitors. I think there could be a paradigm shift if traditional lenders return to the small business market, where a merchant cash advance is really a bridge to a more traditional loan. Perhaps we would do more deals with a lower factor, if our advances were merely a short-term bridge with a defined exit strategy.

    The next several years should be very interesting for the merchant advance sector as the industry matures. I think the industry is here to stay as there will always be a need for this type of alternative financing. I look forward to your responses in the comments below or via our Twitter.


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    This article was written by Ryan Rosett, the CEO and Founder of RetailCapital, and an expert in commercial lending who has been involved in the specialty & structured finance world for over 15 years.

    About RetailCapital:
    RetailCapital is an alternative financing firm that provides working capital solutions to small businesses that are unable to attain traditional bank loans. Founded in Michigan in 2010, RetailCapital has quickly grown to be one of the most prominent firms in the merchant cash advance industry through unparalleled customer service and value to its clients. Leveraging an innovative technology platform, RetailCapital considers a businessís health as whole when qualifying companies, and has provided short-term financing to thousands of small businesses around the U.S. RetailCapital also has partnership programs for independent sales organizations, organizations that serve small businesses, and franchises. For more information, please visit www.retailcapital.com, and follow RetailCapital on Twitter @retailcap.


    Publisher: DailyFunder
    Comments 1 Comment
    1. Capital Stack's Avatar
      Capital Stack -
      Great piece thanks Ryan...


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