May 25, 2017

You’re the Boss Blog: A Modest Proposal to Open Up Small-Business Credit

Searching for Capital

A broker assesses the small-business lending market.

In my last post about the state of small-business lending, I discussed the need to find a way to break through the gridlock in order to open up access to reasonably priced capital for small-business owners and entrepreneurs.

In this post, I would like to suggest that we create mechanisms and loan products that would allow lenders to be paid a percentage of an entrepreneur’s future earnings — irrespective of what company the entrepreneur ends up building or working for. The payments would continue until the obligation was paid off. (I’ve written previously about this idea on my company’s blog.)

While I am sure that many will consider this idea controversial, it’s also fairly simple. If you are an entrepreneur looking for a loan, and you have enough confidence in your business or idea, you should be willing to pledge to pay a percentage of your future earnings — regardless of whether your current idea succeeds — until you have fulfilled your obligation. This way, the lender is betting not just on a particular company or idea but on a person, one who is willing to put his or her neck on the line.

Perhaps this financing could be offered by Federal Deposit Insurance Corporation-regulated banks that could leverage their low cost of capital to help small businesses. Of course, this would require federal bank regulators to think outside of the box, but a form of this type of financing exists. It’s called revenue-based financing, and it involves a lender’s making a loan to a company in exchange for a future piece of the company’s revenue. In this case, the financing is tied to the success of a specific company, and not to the future of the entrepreneur. And it comes with expensive rates.

The market clearly needs new forms of collateral in order to keep rates reasonable and in check. In today’s environment, many small-business owners are forced to use their homes as collateral — but with so many homes underwater, many entrepreneurs do not even have that option. The upshot is that this “collateral crisis” either stymies innovation or forces the entrepreneur to obtain capital from an alternative source at very high interest rates.

In the new model I am proposing, because the lender is assured of a piece of the entrepreneur’s future earnings regardless of whether the current business succeeds, the lender should be willing to be more flexible with terms and rates. And finally, the mechanisms to enforce these loans do exist. If we can track down deadbeat fathers for a piece of their future earnings, we should be able to do so with entrepreneurs.

So what do you think? If you are an entrepreneur, would you consider taking a loan that collateralizes your future earnings? Presumably, instead of paying 40 to 60 percent interest for a six-month loan — as many of us are forced to do today — you might pay 6 percent interest on 10 percent of your earnings until your obligation is paid off.

And if you’re a lender, would you consider making these types of loans? Do you think this new collateral mechanism could open up credit markets and spur innovation and growth?

Ami Kassar founded MultiFunding, which is based near Philadelphia and helps small businesses find the right sources of financing for their companies.

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