Latest posts by Nick Elders (see all)
- Challenges our Small Business Borrowers Face (part 2) - October 11, 2016
- How Online Loan Origination Software Can Help Mission-driven Lenders Appeal to New Customers - October 5, 2016
- Challenges our Small Business Borrowers Face - July 28, 2016
This is the second in a two-part series. During our JumpStart process consulting assessments, we have heard some common threads around the challenges underserved small businesses face and how that impacts their ability to secure financing. I was able to bucket them into six categories and today I am sharing the final three.
Challenges for Education (both traditional and financial)
It’s no secret that low-income areas are often inhabited by low-income residents who, very often, are not as highly educated as their upper-income resident counterparts. While to some, this is an obvious statement, here is a graphic from Annie E Casey Foundation’s paper on early childhood education that explains the concept in more detail: A couple of my takeaways from the graphic:
- In higher income families, almost half of caregivers or heads-of-household hold, at minimum, a bachelor’s degree or higher
- In lower income families, almost half of caregivers or heads-of-household hold, at MOST a high school diploma or GED
Children growing up in low income areas often face serious issues, more frequently, as compared to upper income area children. To name a few: pollution, exposure to toxins (tried the water in Flint recently? Do you think that ever could have happened in Arlington or Falls Church?), excessive noise, violence, family instability, police brutality, hunger, etc. This exposure effects a low-income child’s ability to learn, setting them back from an upper income child. As you already are anticipating, this scenario plays out in lower education levels being attained by low-income children as they grow to adulthood and the situation perpetuates.
If we look at Financial Education, there again, the results are not good. In a recent paper released on financial education (avoiding the term “financial literacy”, I don’t like it), the authors (Olivia S Mitchell – Executive Director – Pension Research Council, and Annamaria Lusardi – Professor – George Washington School of Business) asked embarked on a 10-year research project. They wanted to know if people understood the basic concepts of compounding, inflation and risk. They worked these concepts into three questions:
- Suppose you had $100 in a savings account and interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you let the money grow?
- More than $102?
- Exactly $102?
- Less than $102
- Imagine the interest rate on your savings account was 1% per year but the inflation rate was 2% per year. After one year, how much would you be able to buy with the money in this account?
- More than today?
- Exactly the same?
- Less than today?
- Please tell us whether this statement is true of false: Buying a single company’s stock usually provides a safer return than a stock mutual fund
Only half of survey respondents over the age of 50 got the first 2 questions right. Only 1/3 of survey respondents over the age of 50 got all three questions right. Noting another trend in the data, education played a role in financial understanding as well. 44.3% of respondents with college degrees answered all questions correctly vs. 19.2% of those with a high school degree. As individuals with these low levels of financial understanding move into entrepreneurship and start running a business (either out of necessity or by design), the need for quality financial education and business advising is paramount. CDFIs are uniquely positioned, and in many ways CHARTERED, to provide financial education and business advising. The cost of providing the education and advising is not free, but the results must be measurable and real if organizations are going to continue offering it to / requiring it of borrowers.
General Understanding of Lending Process / Options Available:
In our experience, borrowers of nearly every type regardless of race, location or education level, are trading speed for price. If you look at the rise in the levels of payday lending, online lending and the like – it isn’t the lower interest rate people are after: It’s access. Likewise, borrowers are not all that familiar with the concept of “match funding” – aligning a short term loan with a short term use / aligning a long term loan with a long term use, etc. This often leads to a product / use mismatch. Add to the fact the CDFI Industry is largely invisible, we are difficult to find and we have a hard time competing in today’s marketplace and you’re left with a situation that doesn’t look promising on its face. In the CDFI world, this problem is exasperated by the fact very few of us offer flexible loan products (lines of credit etc.). We continually cite “borrower monitoring” and “loan complexity” as potential roadblocks to offering these products. However, there are canned solutions we can leverage, best practices to be shared and technology resources to be brought to bear that will largely eliminate these roadblocks. Again, through collaboration, we plan to: gain visibility, move up the chain of lender preference and help borrowers through the process of selecting the right financing option for the right need.
In many cases, financing is not available to a borrower due to their readiness. Common issues we see are:
- Lack of formal accounting process / software at the business
- If accounting software is available, it’s under-utilized or inaccurate
- The ability for the borrower to produce financial statements, a balance sheet, income statement, projections etc.
Again, there are solutions we are working on to solve for these problems including working with SBDCs, enabling technology solutions like BodeTree, HPN Blueprint or Mint.com and developing our own business advisory services / partnering with other CDFIs in an effort to help the borrower prepare to embark on the lending process.
As I’m sure you are all aware, there is not a one-size-fits-all approach to solving the issues facing SME’s, and low income communities in general. In one community it may be lack of quality / affordable housing. In another it may be access to living wage jobs, while in another it may be the lack of (or loss of) an anchor tenant holding a community together. The absence of affordable and appropriate healthcare in combination with poor public education may drive families to relocate (if they can). These issues are all:
- inter-related and
- must be viewed holistically
To that end, we are taking a more coordinated approach as of late, involving many roles and players, in our approach to any given need in a community. We realize on our own, we will not provide every answer. “Collaboration combined with innovation” is the mantra for our path forward.