A few years ago, I heard a presentation by Acción about their loan packages for food and beverage entrepreneurs. I was shocked to learn that their interest rates were around 16%, marginally lower than a credit card. For an organization with a mission to help bring affordable loans to small businesses, this seemed insanely high.
I developed a greater understanding of this challenge when starting up Sprout Lenders. We had wanted to set our loan rates at approximately 6%. But in order for us to make a modest return on our investment (2% – 3%) we will need to loan money at 9%. The difference covers the costs of:
- Due Diligence: making sure the borrower has the capacity to pay back the loan. This includes visiting the borrower to see their operations and filing credit reports, etc.
- Administrative Fees: paying a CPA to file our taxes at the end of the year, paying for web-hosting, marketing and other out-reach.
We do not pay ourselves for our time spent reaching out to potential borrowers or processing loans. The proposition looks even more grim when we factor in loan defaults. If one of our borrowers is unable to pay back their loan, then we’re looking at a negative return (i.e. loss).
Many small businesses need an infusion of capital to grow; whether it’s to purchase a new truck to increase delivery capacity, or a new oven to increase kitchen production. But by the nature of these small businesses, bank loans may be difficult to obtain if your business does not have a track-record yet (that is, you’re just starting out) or you had financial troubles in the past. They are considered risky loans.
For Accion to provide a sustainable business model, they must charge these rates.
There are other sources of capital for entrepreneurs that are mission driven. As such, the investors forgo a higher rate of return in exchange for supporting businesses that align with their values. They tend to be supported by grants, loan loss reserves and guarantees.
While it can be frustrating to not qualify for traditional capital, it’s good to know that there are other options available. In order to best prepare yourself to qualify, start now. Managing your finances now will help you later when you need a loan. See the calendar of events for details on workshops that will help you grow your business by managing your finances today.