Cash crunch: small businesses get creative
Banks have all but stopped lending, so entrepreneurs are turning to nontraditional sources of funding to keep their businesses running.
(CNNMoney.com) -- Unable to get bank loans and credit lines, small business owners are turning to other sources for the cash they need to run their businesses.
Bank financing is harder to come by than ever: The number of small businesses using bank loans is at a 15-year low, according to the National Small Business Association. The SBA's flagship loan program, which offers banks guarantees on loans they make to qualifying small companies, backed 30% fewer loans in 2008 than it did in 2007.
Entrepreneur Tim Murphy went shopping for financing late last year to open a retail gourmet-popcorn store. Armed with experience running small companies and a detailed business plan honed with the help of his local small business development center (SBDC ), Murphy was optimistic.
"I went to national banks, regional banks, small banks - every one advertising that they want to help the little guy get started in business," Murphy said. "There were about 12 banks I made presentations to. All 12 turned me down."
Frozen out at the banks, Murphy went online to check out a suggestion from his SBDC business consultant about person-to-person lending. He found LendingClub, one of several Internet ventures that directly connect borrowers to individuals with cash to lend.
Dubbed "social" or "peer-to-peer" lending, LendingClub and rivals like Prosper.com pair individuals willing to lend cash with borrowers who sign up with the site. Lenders flip through profiles of potential borrowers, who release their credit reports, to see descriptions of how they plan to use - and repay - the borrowed funds. If lenders see a listing they like, they chip in to help fund it, committing as little as $25 or as much as several thousand.
Lenders earn interest on their loans at rates similar to those charged by credit-card companies. If borrowers default, that's reflected on their credit reports. Like a mashup of Facebook and eBay (EBAY, Fortune 500), LendingClub and other peer-to-peer lenders use social networking and feedback systems to build connections between their borrowing and lending members.
Murphy put up a LendingClub profile describing his business plan and seeking a $25,000 loan. Within two weeks, he had it, cobbled together from 74 lenders investing amounts that ranged from $25 to $12,450, at a 12.49% interest rate. Murphy's Popcorn Store opened its doors in Marietta, Ga.'s Historic Square in April.
In New York City, Marc Matthias and his business partner, Benny Rivera turned to social lending to expand their business in May. The two French Culinary Institute-trained pastry chefs run a custom cake outfit Diverse Desserts, which they registered as an LLC in late 2007.
The partners worked out of rental kitchens but longed for a permanent baking studio. Securing a lease and equipment required a hefty cash outlay. Matthias pitched a few banks but got no interest.
"The SBA advisors told us, 'We have clients who make millions in revenue each year, and even they are getting denied or having their funding cut down. They'll request $1 million and get $100,000,'" Matthias said.
So he went online to Prosper.com, posted a profile about Diverse Desserts, and requested $25,000, Prosper's maximum loan size. Prosper's system gives lenders seven days to ante up for loans they'd like to fund. If at the end of the seven days, the loan isn't fully funded, the potential borrower receives nothing and has to start over with a new request. Matthias watched nervously as Day Six passed and Diverse Desserts hovered at the 60%-funded level.
But in the listing's final hours, more than 600 potential lenders piled in, competing to offer the lowest interest rate. Diverse Desserts ended up getting its three-year, $25,000 loan at an 11.5% interest rate - a full percentage point lower than the rate Matthias applied for at the bank.
"Knowing that the interest payments are going to individuals who put their faith in our business, not to a financial institution, makes me feel good about paying it," Matthias said.
A more conventional - and expensive - option for cash-strapped business owners are credit cards.
Husband-and-wife team Jeff Smith and Carmen Cosby are juggling a stack of them to cobble together the cash they need for You are my Sunshine, a maternity boutique and childbirth education center they opened in Wilmington, N.C., last year.
Smith and Cosby pitched several banks to no avail, so they turned to low-interest cards and temporary 0% deals, pulling together the $50,000 they needed to open their store. Now, a year and a half later, they're struggling to keep up with rising interest rates. Although they've never missed a payment, some of their rates have crept up past 18%.
"We calculated that we could pay a 10-year, $200,000 loan at 10% for less money than we're paying per month now," Smith said. "All of our profit right now is going to pay off the interest."
That's taking its toll on the business. Carmen Cosby's mother and sister moved to Wilmington last year to help Smith and Cosby with You are my Sunshine, but the couple recently sent their relatives back to New York: "We couldn't afford to keep them here," Smith said.
The credit crisis isn't just holding back new businesses, it's hurting the prospects for existing outfits.
That's what's happening at OC Surf 'n Sport, a Dana Point, Calif., bodyboarding gear business Eddie Solomon started in his garage five years ago.
In January, Solomon caught his big break: a major sporting-goods retailer placed an order for Solomon's bodyboards. He took out a $25,000 credit line at a local bank to finance production, delivered the goods to his customer in March, and paid off the credit line at the end of June.
The boards sold well, and another big order came in - but when Solomon went to tap his credit line again, he found it was gone.
Frustrated, Solomon is saving up his cash and expects to rely on credit cards to finance the rest of the order. "Hopefully those credit lines will hold up," he said. "I'll just have to deal with the very high interest rates."
High, and getting higher. Sixty-three percent of business owners polled by the National Small Business Association in August said the terms of their business credit cards have gotten worse in recent years. Last month a rash of credit-card holders with Advanta, a small-business card issuer, opened their bills to find their interest rates had abruptly tripled.
What drives Solomon crazy are the missed opportunities. He figures he could have doubled his business this year if he had access to the financing he needed.
You are My Sunshine is focused on simply surviving. Jeff Smith hopes his company will hold out long enough to emerge from the crush of high interest rates.
"We don't feel very safe," Smith said. "We're still making our payments on time every month, but it's definitely stressful. If we had two or three bad months in a row for some reason, it would be difficult to see us continuing."