| Getting Personal: Small Cos Seek Credit Where They Can Find It |
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By Arden Dale A Dow Jones Newswires Column 1231 words 17 October 2008 16:55 Dow Jones News Service English (c) 2008 Dow Jones & Company, Inc. NEW YORK (Dow Jones)--Small businesses are finding other places to borrow money as banks freeze credit. Alternative credit sources, such as "factoring" and non-traditional loans can mean the difference between survival and extinction for those refused by banks. Done wrong, though, borrowing from an alternative lender can mean much higher costs or other problems down the road. New troubles in peer-to-peer lending are a reminder that people need to look carefully before signing onto a strategy. Specifically, entrepreneurs should study the true costs of such borrowing, according to Steven Bloom, a past chairman of the Atlanta chapter of SCORE, the volunteer arm of the U.S. Small Business Administration. "If the cost of money is more than their profits, they should not being going forward," said Bloom, who teaches business finance at the SBA and Emory University. Factoring, a practice that has been around for centuries, has attracted a wave of borrowers in recent months. Factors buy receivables from companies and lend them money in return. For example, Company A has invoiced Company B for $1,000 but can't wait 45 days to collect the money. It sells the invoice to a factor, who gives Company A about 80% of the money it is owed right away. The factor collects the rest from Company B over time and gives it back to Company A, minus a fee. Brian Birnbaum, a founder and director of Canadian-based factor Liquid Capital Corp., said he thinks the next two or three years are going to be "great times for the factoring industry." Liquid Capital, which recently expanded into the U.S., owns a chain of factor franchises. It reported a 55% increase in factoring volume for September, compared with the same month last year. Factoring can be a good resource for businesses, but entrepreneurs need to watch out for high interest rates. The rate, which factors call the "discount," is generally between 2% to 6% of the amount outstanding. It is generally charged per month, said Bloom. A business owner can end up paying a lot more than 2% a year if it takes the factor a while to collect the rest of the money owed the client. If a "factor charges you 3% per month and it takes you three months to collect, the effective cost is 9%; on an annualized basis, that's a 36% annual interest rate," said Bloom. "It's pretty expensive money." Bert Goldberg, executive director of the International Factoring Association, said entrepreneurs should look into whether a factor they are considering follows industry best practices. That can be done through the IFA Web site at www.factoring.org. Non Traditional Loans Firms that facilitate loans between people who already know one another are another source of money. Virgin Money USA, a well-known example, had its best-ever period for small business loans in the third-quarter, and expects the numbers to be up even more for the fourth quarter, according to chief executive and founder Asheesh Advani. The bottom line, said Advani, is that "small business owners have had a particularly difficult time getting financing from banks." Virgin Money USA sets up loans between family and friends and manages the paperwork. Virgin acquired the business from CircleLending last year; loan volume grew from $200 million in 2007 to $370 million this year. Virgin Money's median loan is about $15,000, though loans range from $10,000 to $300,000; the average annual interest rate is 7.6% for small business loans. The company's loan-default rate has never exceeded 5%, according to Advani, due to its "secret sauce," he added, a process that lets people restructure loans for free. The company spreads payments out over a longer period if a borrower is having trouble making payments. Stewart Sonneland, who started a data storage and recovery company Strategic Hardware in 2006, took out his first loan for the business in May, from Virgin Money. The firm helped Sonneland put together a loan from three friends who know his business well. Sonneland didn't bother going to a bank for the credit because he thought the prospect of a traditional loan for him "was dead on arrival." Though he may qualify for an SBA loan in 2010, Sonneland said he thinks he may prefer to stick with loans from friends and families. Given the current environment, Sonneland doesn't want to waste time filling out loan applications and putting in all that a bank loan would require. Going to people who already know him works well. "In terms of the return on my time, it makes more sense to pursue private lending," said Sonneland. Peer-to-Peer Lending Runs Into Trouble Peer-to-peer lending, in which borrowers seek out loans from individuals they don't know, has also attracted a lot of small businesses. Prosper Marketplace, Inc., which runs Prosper.com, has been seen as a successful example in the niche, along with others like Lending Club. This week, though, it said it froze some of its activity because it is registering with securities authorities as a "step toward making the secondary lending market available to the community." Prosper said it has stopped accepting new lenders or allowing new commitments from existing ones. Borrowers with existing loans won't be affected; those seeking a loan can create a new loan listing, which Prosper will "endeavor to fulfill through alternative sources," the company said. The New York Times reported that monthly loan volumes at the company have been declining since the credit crisis deepened this spring, and that Prosper now faces the possibility that lenders may take their money off the table while waiting for the Securities and Exchange Commission to evaluate its filings. The Times' report also explored problems among several of Prosper's rivals. Virgin Money issued a statement noting that its business is fundamentally different from peer-to-peer lenders like Prosper. The big difference, it said, is that Virgin Money markets its services to lenders and borrowers, rather than marketing loans as investments to lenders. Bloom, who favors peer-to-peer lending generally, said it's important that the niche remains available to business owners struggling to get capital in the current environment. His advice for those contemplating a peer-to-peer loan: Look at the fine print to make sure the money isn't too expensive. And, "if you really believe your business is viable and the additional funding is going to help you stay alive, why wouldn't you get one these loans?" (Arden Dale is a Getting Personal columnist who writes about personal finance; she covers topics including tax and estate planning, retirement, investment strategies, and financial needs of small businesses.) |
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