By Warren S. Galloway, Jr., SWOT City Portfolio Manager
Most people believe that when you apply for a microloan the “one fits all” concept will be the norm. With microlending, this is not true. Microlenders lend up to $50,000 with slightly higher interest rates than bank loans; however, they have a much more flexible underwriting criterion. Are microlenders lending in Detroit? Absolutely. They are providing access to much-needed capital for entrepreneurs throughout the city. Microlenders usually will lend to entrepreneurs if they don’t qualify for traditional small business loans, but what we are seeing in Detroit is that microlenders and traditional lenders are partnering on loan deals with entrepreneurs. Community lenders are filling in the lending gap between microlenders and traditional lenders (i.e. Detroit Development Fund, Invest Detroit and other similar lenders).
When I give presentations on microloans, I encourage entrepreneurs to be informed. I also stress to them that just because they can be approved for a loan, does not mean it is the right loan for their business. So, when do you know if a loan is right for your business? I created the following list of 12 points to review before applying for a loan. This list can also be used to ask each lender questions about their loan program:
Line of credit vs term loan
A line of credit can be accessed anytime. You will need capital, and as long as you make payments on the loan, the line of credit will be available to use again. It is great for working capital or gap funding when you have outstanding receivables. However, term loans are better to use when you need to cover the cost for the development of brick and mortar, equipment, or other long-term assets.
Type of business they will lend to
Each lender determines the types of industry they are willing to lend funding. Some lenders might not lend to restaurants but will lend to retail clothing stores. You have to ask the lender if they lend to your industry before submitting an application.
I’ve already mentioned that microlenders only lend up to $50,000, but you have to ask other lenders what is their minimum and maximum loan amount. Each lender is different, and you don’t want to waste time with a lender who cannot lend you the amount needed for your business.
Make sure that a lender will lend in your neighborhood. Some lenders will only lend to owners whose businesses are located in certain neighborhoods, communities, regions, states, etc.
Ethnic, race, nationality, or gender qualifications
Yes, some lenders have a targeted market for lending. There are lenders who lend to certain minorities, immigrants, religions and genders. Before applying for a loan, you need to research ahead of time to determine if there are ethnic, race, nationality and/or gender qualifications.
Collateral or not
Some lenders require that you have collateral in order to be approved for a loan. Each lender will tell you what they will accept as collateral. There are some lenders that don’t require collateral. You should research different lenders to see if you must have collateral before you fill out the application.
Percentage of personal equity
What is your personal investment in your business? Some lender will require that you have “skin in the game.” So, what is the norm? Each lender will assess your equity position to determine whether or not you meet the standards. It could be anywhere from 5% – 20% before you are approved for a loan. Make sure you ask about your required equity position.
Is a business plan required or not?
Almost all lenders require a business plan, which is a road map for the operation of your business. You should have a business plan anyway, because other programs might require a business plan. Surprisingly, there are some lenders that don’t require business plans. So, do your research to see if you need one. In theory, all businesses should have a business plan!
Grace period or interest payments
It’s very, very important to know up front whether you will receive a grace period or have interest-only payments. If you are doing a buildout of a brick and mortar, you should look at lenders who understand what you are going through as you prepare for your business to open. For instance, it could take you two to three months to finish the construction phase, so you want to know if you are paying on your loan during this period or paying interest only. Keep in mind, most entrepreneurs are not generating revenue during this period, so you don’t want to close on a loan that will require payment 30 days after the closing.
The reality is that during the first three to six months or longer, you will be building your business and growing your revenue. Therefore, it will take time before your revenue exceeds your expenses. So, unless you have cash saved, how are you going to meet your expense obligations? One way is to apply for working capital to cover these costs over a period of time until your revenue will cover your costs.
Interest rate is one of the factors, but it is not the main factor. This is why it is listed as the next to last point. Once you have reviewed the above 10 points, then you need to look at the interest rate. Although a lower interest rate is important, it still might not be the determining factor in selecting a loan.
Finally, what if you have superior customer service from a lender with an interest rate a point higher than another lender with so-so or subpar customer service? Who are you going to get your loan from? You will have to go with your gut feeling. Customer experience is another factor to consider; it makes a huge difference!
If you want to learn more about the concept of identifying the right Microloan(s) and lender(s), please register to attend the SWOT City Neighborhood Workshop Series “Access to Capital: Microlending Edition” on August 22. Register here.
A great opportunity to network with microlenders, bankers, service providers, small business agencies and other entrepreneurs is during the National Microloan Conference at TechTown Detroit, September 27 – 28. To learn more information about this conference, go to www.microloanconference.com.