Capital Raise Blog Series - Vol 12 - What is Microlending?

As investment bankers, RKJ Partners possesses a breadth of knowledge and experience in advising clients that seek growth capital.  In our latest blog installment, we define and discuss the evolution of microlending.

Before the economic collapse, microlending (also called microfinance) was a concept typically associated with developing and emerging countries. But the growing disparity of income distribution, the loss of blue-collar jobs, the shift from relatively well-paying manufacturing jobs to minimum wage service-sector jobs, corporate downsizing, outsourcing, and unemployment all have contributed to the increased demand for smaller loans in the United States.  As a result, the popularity of microlending is currently at an all-time high and has the potential to have a real impact on the business culture and climate of the United States.  Microlending was specifically earmarked in the 2009 economic stimulus bill which granted $54 million to the Small Business Administration (SBA) for lending and technical assistance to microlending groups. In addition, cities such as San Francisco and New York have taken initiative by expanding and/or introducing their own microloan programs.  Microlenders expect their loan applications to continue to rise as other financing streams remain unachievable for most entrepreneurs and small companies. 

The evolution of microlending in the U.S

The foundation for microlending in the United States was laid in 1977 through the passage of the Community Reinvestment Act (“CRA”), which first started the process of banks being rated by regulators based in part on their participation of funneling resources directly or indirectly (through nonprofit organizations) into low-income communities.  It was not until 1991 that the SBA first recognized “microenterprise” as a separate category of business and established the Microloan Demonstration Project.  Also in 1991, a trade organization for microlenders, the Association for Enterprise Organization (“AEO”), was founded.  By 1992, only a year after this official recognition, there were already 108 separate organizations working in American microfinance. Even with this sudden surge of interest, by 1995 no microlender in the United States had come anywhere close to breaking even. Each individual microlender was functioning strictly as a charity, unable to make a sustainable difference.  In 1999, federal funding for microlending programs increased through the passing of the Program for Investment in Microentrepreneurs (“PRIME”) Act; however, during the Bush administration era from 2001 to 2005, federal funding for microfinance was cut drastically.  By 2002, there were 650 separate organizations in microfinance.  Between 2002 and 2008, the total number of microenterprises in the United States grew from 21.5 million to 25.4 million, which was a growth from 13.1 million in 1999.  Microenterprises now make up roughly eighty-eight percent of the total businesses in America.

Today, virtually all microlenders in America are organized as non-profit organizations and serve as local intermediaries for federal funds. The federal funds are first loaned to the specially designated nonprofit, community-based organizations that then deal directly with the borrowers.  The SBA dominates the American microloan market with approved loans averaging approximately $13,000.  There are also a few non-profit organizations in the private sector that issue smaller loans without federal backing.

How microlending works

Microlending involves providing small, short-term loans to small business concerns and entrepreneurs. Mainly through the SBA, funds are made available to specially designated intermediary lenders, which are nonprofit community-based organizations with experience in lending as well as management and technical assistance. These intermediaries make loans to eligible borrowers.  Each intermediary lender has its own lending and credit requirements.  Generally, intermediaries require some type of collateral as well as the personal guarantee of the business owner.  The maximum loan amount is typically in the $35,000 to $50,000 range, but the average microloan is about $13,000.  Loan terms vary according to: size of the loan, planned use of funds, requirements of intermediary lender, and needs of the borrower.

Each intermediary (lender) is required to provide business training and technical assistance to its micro-borrowers. If you apply for microloan financing, you may be required to fulfill training and/or planning requirements before your loan application is considered. This business training can be helpful to you as you launch or expand your small business. 

Microloans can be typically used for the following business purposes: 1) working capital, 2) the purchase of inventory or supplies, 3) the purchase of furniture or fixtures, and 4) the purchase of machinery or equipment.  Typically proceeds from a microloan cannot be used to purchase real estate.

Key steps to take first

• There are some steps you can take before asking for a microloan:
• Put together a business plan that includes an analysis of your market and its competitors.
• Update your resume and obtain the resumes of other senior managers.
• Pull your business and personal tax returns for the last three years.
• Provide revenue, cash flow and profit expectations for the next three years with thorough explanation.
• If you have an existing business, assemble your financial statements for the last three years.
• Prepare as detailed an explanation as possible for why you need the loan and how it will help your business prosper.
• Identify microlenders in your area. You can find them at The Small Business Administration, or SBA, and at Microenterprise.