State Of Small Business and Working Capital Needs (5-Part Series)

Part 1: The State Of Small Business and Working Capital Needs in Texas Growth Industries.

Part-one of a five-part series focusing on The State of Small Business in 3 Texas growth industries; Healthcare, Retail and Food Services, and their credit needs to support expansion and operations.  Series concludes with an overview of how online lenders have stepped in, Funders & ISO’s alike, to provide the funding to close the credit gap in support of Small Business working capital needs.

The founders of Accord Business Funding have been financing Texas for almost 5 decades.  Recent comments from Mike Ballases, Founder, spoke to the changing nature of traditional banking, challenges to small businesses and meeting the small business credit gap.

“Over the last 40 years, we have seen the banking industry evolve thru consolidation. Today, 1/3rd of banks that existed 40 years ago are still in business.  In addition, the cost of customer acquisition continues to increase as does the cost of supporting small business loans.  As a result, traditional banks are less inclined to support local small business, especially funding request less than $250K, which is around 75% of all small business lending request.  The Alternative Finance Industry has stepped in to fill the credit gap.”

Recently, the Federal Reserve released the 2017 Small Business Credit Survey (SBCS). The survey involved 12 Federal Reserve Banks which gathered perspectives on small business decisions, outcomes, and financial needs. This information is very important for ISO’s and Funder’s as they identify credit gaps and develop meaningful working relationships to meet the working capital needs of small business. The findings of the survey provide a clear look at the credit experiences, debt holdings, and the performance of small businesses across the country. In addition, the Harvard Business School Working Paper, The State of Small Business Lending:  Innovation and Technology and the Implications for Regulation, provides additional context to the Federal Reserve Survey.  With reference to the 2017 Small Business Credit Survey, this article will look at the overall business environment and outline growth expectations, financing shortfalls, and financial challenges of firms across the country.

Going into 2018, the survey showed that businesses reported stronger revenue growth and increased profitability, and some of the businesses experienced continued financial challenges. Generally, the survey shows:

  • Improved business performance in 2017, and increased optimism for employment and revenue growth in 2018.
  • Reduced demand for new financing, with a small number of companies applying for new financing than in the previous years and half of the non-applicants reporting that they had enough financing.
  • An improved financing success for applicants, with a bigger number of applicants getting the whole amount that they requested and higher success rates for line of credits and loan applicants as compared to 2016.
  • A modest increase in the number of applicants seeking financing from online lenders, with the highest application rates being with self-reported medium and high-credit risk companies.
  • Continued financial issues. A majority of the financial challenges were wages and operating expenses, and also credit availability for some companies, especially recent credit applicants, startups(0-5yrs) and micro firms with $100k in revenues or lower per year, and businesses in the hospitality and leisure industry.

Improved Performance

A majority of the businesses reported that they were profitable and their revenues were growing in 2017. The net share of the businesses reporting employment growth, revenue growth, and profitability increased from the levels of 2016. The expectations for employment and revenue reached an all-time high since 2015. Approximately 66 percent of the businesses anticipated increased revenue for 2018, and 44 percent of the businesses expected that they would hire more employees in 2018.  The increase in business performance has resulted in less demand for existing firm financing, however, in Texas, the strength of the economy has resulted in a brisk increase of new small business entering the market and a need to establish credit relationships to fund business operations and growth.

Decreased Demand for Financing

The demand for new financing decreased, with 40 percent of the businesses applying for financing, down from the 45 percent in 2016. Just like in the previous years, a majority of the applying firms were looking for $100k or less in funding; three-quarters of the firms were seeking $250k or less. Although a majority of the financing applications were for expansion, the borrowing needs of the firms reflected their cost pressures and uneven cash flow, with sizable shares borrowed to finance operating costs including salaries (43 percent) and to refinance (26 percent).
On average, applicants seeking financing reported a higher incidence of risk factors that those who never applied. A smaller percentage of these applicants were profitable, and the bigger percentage of these applicants reported that they experienced challenges in the previous year. Businesses sought financing frequently at big banks (48 percent), small banks (47 percent) and online lenders (24 percent).
Nonetheless, a considerable number of 18 percent sought funding from other lenders, including government entities, private investors, nonprofits, friends/family, farm lending institutions, and equipment/auto dealers. 50 percent of the non-applicants never applied since they had enough financing. Another 26 percent of the non-applicants were opposed to taking any new debt, and 13 percent never applied because they believed that their applications would be rejected.  Of interest, Small Businesses tend to put more weight on where they felt they would be approved when considering financing, versus any other factor like terms, rates and cost of capital among others.
Financial Gaps
A bigger percentage of the applicants (46 percent) were awarded the full loan amount that they had applied for as compared to the 40 percent of 2016. Businesses also reported higher success rates for lines of credit and loan applications, with 58 percent of them getting all the credit that they requested up from the previous year figure of 53 percent.
However, financial shortfalls were common among micro-businesses (those firms with revenues of $100k or less) and startups (0-5yrs). 61 percent of startups and 70 percent of micro businesses applicants experienced financial shortfalls. Other funding shortfalls varied across the different self-reported credit-risk categories. 44 percent of businesses with low credit risk experienced financial shortfalls, as compared to the 71 percent of the medium credit risk businesses and 90 percent of businesses with high credit risk. Businesses attributed these financial gaps mostly to the inadequate credit histories and the inadequate collateral.
Increased Funding Applications to Online Lenders
Applications for funding to online lenders increased from 21 percent in 2016 to 24 percent in 2017. This figure is much higher among self-reported medium/ high-risk credit businesses, with 40 percent of the firms applying to online providers- almost the same percentage that applied to big banks (49 percent) and small banks (47 percent). Self-reported high and medium credit risk applicants were most successful in getting funding for cash advances, lines of credit, and funding for loans. 71 percent received funding from online providers, as compared to the success rates of 47 percent at small banks, 35 percent at large banks, and 26 percent at credit unions.
The applicants to online lenders reported that they were attracted by the lack of collateral requirements, improved funding chances, and the speed of credit decisions. Net borrowers’ satisfaction with online providers has increased to 35 percent in 2017 as compared to 19 percent in 2015. Nonetheless, applicants to online lenders reported challenges with unfavorable repayment terms and high-interest rates more often than applicants who borrowed from other lenders. Applicants to online lenders were reported to be the least satisfied as compared to the applicants who received funding from other types of lenders.
Industry Financial Challenges
64 percent of the businesses experienced financial challenges in 2016. While the most common types of financial challenges generally were operating costs (40 percent) and credit availability (30 percent), these challenges were especially severe for businesses with annual revenues of $100k or less (with operating costs taking 52 percent and credit availability taking 36 percent) and for startups (with operating expenses taking 46 percent and credit availability taking 39 percent).
For hospitality and leisure businesses, 48 percent reported that they experienced difficulties in paying for operating expenses, and another 38 percent had difficulties in making debt repayments; these shares are much higher than for the businesses in other industries. A majority of businesses addressed these financial challenges by using personal funds. Approximately 67 percent of business owners used their personal finances to do so, and 36 percent of them took on additional debt.
The 2017 SBCS with its huge breadth can shed light on different sectors of the small business population, including self-employed individuals (non-employer firms), women-owned firms, minority-owned firms, microbusinesses, growing firms, startups and the credit availability and challenges to support growth and operations. In the next articles we turn our focus to the credit needs and performance of 3 core small business growth markets in Texas; healthcare, restaurants, and retail. We conclude the series with a close look at online funders closing the credit gap to provide the working capital needed for small business expansion and how these ISO’s work with funders like Accord Business Funding to exceed Merchant needs.
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