Raising Capital In An Economic Slowdown
Posted by iBlog on May 13, 2008
Raising capital is difficult under normal conditions, and a tight credit market and fears of an economic slowdown have made the challenge harder. Unproven early-stage companies could face a tough time finding funds from informal investors who are less willing to take risks in an unsteady economy. Firms looking for equity investments should expect to give up more ownership for less cash than during flusher times. For established businesses that are good credit risks, lower interest rates will make borrowing more attractive. Here’s what you need to know.
Where should I look for capital if I have an existing business?
A good source might be a loan or credit line from your local independent bank (BusinessWeek.com, 12/26/06), especially if you already have a business relationship there. Subprime mortgage defaults have hit banking giants (BusinessWeek.com, 1/15/08) like Citigroup (C) hard, but most smaller banks don’t face the same losses. “Community banks have very solid balance sheets and liquidity. They’re not having to do the large writedowns for the subprime mess because they’re traditionally more prudent lenders,” says Paul Merski, chief economist at the Independent Community Bankers of America, a trade group. “They have money to lend.”
Is now good time to take out a loan?
Yes, if you can get it. The Federal Reserve has dropped its rate target for overnight lending by 2.25 percentage points since the summer, to 3%, in an effort to ease the credit crunch. That means banks can offer borrowers lower rates and make the same profit. “If you have a good business and you have a good relationship with your lender and interest rates are coming down, it may be even less expensive to borrow,” says Merski.
Will I face tighter credit standards?
Banks are still looking to lend to companies that have the ability to repay, according to Rebecca Macieira-Kaufmann, executive vice-president and head of Wells Fargo’s (WFC) small business segment. “In any economic environment, we’re going to want to look at a profitable business, an established business that has a history,” she says. The same credit standards apply for business loans, but an economic downturn could make it harder for you to meet them. “What will happen in a stressed economic environment is you may have fewer receivables, your collateral may be worth less,” Macieira-Kaufmann says.
Lenders are looking closely at the region and the sector that loan applicants are in, she says. You should demonstrate that your business is resilient enough to weather an industry slump. For example, businesses that thrived off new-home construction should show that they can shift to existing homes.
What if I my credit isn’t good enough?
There are nonbank options available for businesses that can’t land traditional loans. One new company in this space, On Deck Capital, offers loans of up to $100,000 to small firms based on their cash flow, rather than the owner’s personal credit rating. “We focus on loans to small businesses who can’t qualify for bank loans,” says Mitch Jacobs, On Deck’s CEO. “We’ve entered the market to fill the gap.” Jacobs says interest rates are “in the ballpark” of traditional bank loans. Borrowers have to be in business for at least a year and show they have adequate cash flow of at least $3,000 a month in credit-card volume