Raising Money

Microlending as a Small Business Funding Source

Financing a small business is a little easier these days, thanks to the SBA Microloan Program, which grants very small loans to start-up businesses. We discuss how microloans work and why getting a microloan may be a smart financing move for you.

Financing a small business can be tough.

Lack of earnings history, lack of experience, and lack of significant collateral conspire to make financing a seemingly no-win situation.

But no matter how small your business is, financing is available though something called "microloans," an increasingly popular funding option for small business owners around the world.

As the name implies, microloans provide relatively small amounts of financing for cash-starved small business borrowers. Although microloans is a general term, there is also a specific SBA Microloans Program that is very attractive to entrepreneurs.

Microloans are typically administered through community-based, nonprofit organizations interested in helping businesses get on their feet.

Although microlending isn't for everyone, there are some notable advantages of microfinancing, as well as some disadvantages. Here's what you need to know to determine whether a microloan is right for you.

Advantages of Microloans

Availability is one of the biggest advantages of microfinancing. Since these loans are designed for small business owners trying to get their business off the ground, they are relatively easy to obtain compared to a traditional small business loan at your local bank. Unlike other forms of financing, microloan proceeds can be used for any purpose provided it relates to the business.

Additionally, since microloans are administered on a local level, it's easier to develop a relationship with your lender. Rather than dealing with an impersonal corporation whose headquarters is hundreds of miles away, you will be dealing with someone who understands the pressures and needs associated with doing business in your local community.

For new small business owners, microlending also provides an opportunity for brushing up on your business skills since most microloan programs require borrowers to participate in business-based training and technical assistance through the sponsoring nonprofit organization.

Disadvantages of Microloans

If microlending sounds like it might be a good fit for your small business, there are some disadvantages you also need to consider, with loan size being the most significant drawback.

Even though the maximum size of an SBA microloan is $35,000, the average microloan only amounts to about $13,000. Maybe that's all the financing you need, but $13,000 doesn't go very far in many small businesses. For most capital purchases, you're probably better off pursuing a different form of financing.

Also, most microlenders will require some form of collateral against your loan. Although the collateral requirements are less than they would be for a larger, commercial loan, it's unlikely that you'll be able to walk away with financing for a handshake and a smile.

Finally, critics of microlending point out that its small loan size creates a tendency for small business owners to borrow for operating expenses rather than capital investment in the business.

Financing operating expenses is frowned upon since it either prolongs the life (and debt) of a business that will never be profitable or creates a never-ending cycle of borrowing as businesses pay off one loan by taking out another.

In any case, you should consider whether the loan proceeds will actually enhance your ability to do business or whether the loan will simply be used as a stop-gap measure.

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