A Hand Up: In the U.S., microfinance gives the smallest businesses a chance to grow
Tim Flanagan strolls the streets of the Washington, D.C., working-class neighborhoods where he works and points out businesses that were launched with his help — a yoga studio, a falafel house, even an environmental engineering consultancy. In each case, a small loan from his community investment group had a big impact.
“We really enjoy helping people grow their businesses, and being a partner in their success,” Flanagan says.
Organizations like Flanagan’s Washington Area Community Investment Fund provide an alternative avenue of funding for budding entrepreneurs. Called microfinance, it gained prominence not on Wall Street but in the world’s poorest countries. In India, Brazil, Bangladesh and elsewhere, lenders have helped millions of the world’s most impoverished people, street vendors and the like — establish small businesses and grow their profits.
Microfinance has a lower profile in the United States, but it is growing: In the fiscal year that ended last September, microlenders provided nearly 40,000 loans, more than triple the number from just three years earlier.
“Microcredit in the U.S. has taken a somewhat different tack than in the developing world,” says Joyce Klein, director of the Aspen Institute’s Microenterprise Fund for Innovation, Effectiveness, Learning and Dissemination (FIELD), a Washington-based microfinance evaluation program. “Its focus has gone beyond the very poorest, to people who are struggling economically or may have challenges accessing traditional bank financing. And its goals go beyond alleviating poverty to building financial security, creating jobs, and even facilitating economic development.”
FIELD estimates that every dollar spent by a microfinance lender produces over $5 in benefits, in the form of profits to the business owner or wages to the owners’ employees.
A HELPING HAND
WACIF, where Flanagan is executive director, has been issuing microloans since 2001 with the support of banks, foundations and other contributors. They’ve helped people like Joe Andronaco, founder of a green construction firm called Access Green. When Andronaco’s co-owned construction business lost its largest contract during the financial crisis, he maxed out his credit card and even cashed out his retirement plan to make his vendors whole. But the business never fully recovered, and when Andronaco decided to spin off his new green construction business, his credit score was still in bad shape. Most lenders balked at helping him. But not WACIF, which dug deeper into the reasons for his credit score and took a closer look at his financials before offering him a credit line.
Starting from two employees in 2012, Andronaco now employs 10 and takes in about $1 million in annual revenue. “Not only did WACIF help me get back on my feet, they helped me capitalize on my success, by expanding my credit line” he says. “This year we are looking to transition to a conventional bank.”
Even in the best of times, the newest and smallest businesses face big challenges in getting the funding they need to grow. Banks can be reluctant to lend to budding entrepreneurs because the failure rate for new businesses is high, and the cost of processing very small loans is nearly the same as for larger ones. Funding a business in the earliest stages is especially hard for people of low and moderate income. People from wealthier backgrounds may be able to borrow from a rich uncle, take out a home loan, or max out their credit cards. People of more modest means may not have wealthy connections or own a home. And they are prone to financial stresses — like a lost job or a family health problem — that can hurt their credit.
“If it weren’t for that loan, I wouldn’t be in business,” Brown says.
Many microfinance lenders help borrowers build or repair their credit and develop their business savvy with the aim of helping them get a larger, conventional bank loan in the future. As a typical microlender, WACIF helps borrowers in areas including financial management, marketing and business planning. The help is provided through guidance from loan officers and from community volunteers from various business fields.
U.S. microlenders typically focus their services on immigrant or working-class neighborhoods and work hard to understand their needs, Klein says. “They tend to hire loan officers with language skills appropriate to these communities, and they’ll have a lot of specific knowledge about the kinds of businesses that are more common among their populations, like food trucks or daycare.”
Even with its more forgiving approach, Flanagan’s group funds only 5 percent of clients who come through the door each year. But it also offers business management seminars taught by professionals of all stripes as well as counseling to current and aspiring entrepreneurs. It’s open to everyone, and all free of charge.
In the world’s poorest countries, microfinance has become big business. Consumer banks are scarce, leaving poor entrepreneurs with a stark choice: a microfinance lender or a loan shark. The lenders charge less than the sharks, but they still charge enough — about 28 percent a year on average — to become prosperous and self-sustaining institutions.
In these countries, a loan of a few hundred dollars may be enough to lift a family out of poverty. In the U.S. average loan size is much larger at $14,800. But U.S. microfinance lenders typically charge rates in line with traditional bank loans — averaging about 8 percent.
Microfinance faces some competition from a new crop of alternative lenders like Lending Club and Kabbage that promise fast and easy access to loans and credit to small businesses. These new lenders may reach into the markets served by microlenders if they can offer small loans based on different criteria from traditional lenders, Klein says.
But nonprofit microlenders are unique in their focus on underserved communities and hands-on advice. “There are plenty of people who need affordable loans for their small business, and it will take a diverse range of products — whether offered by non-profits or for-profits — to meet their needs.” Klein says.
As microfinance has grown in the U.S., it’s brought in established players from overseas. These include Grameen Bank, a microfinance pioneer whose founder won the Nobel Peace Prize, and Kiva, an online platform that allows anyone to lend to businesses around the world. Both Grameen and Kiva now offer loans in the U.S. Eventually even traditional lenders may get into the microloan business, says Christine Pratt, an analyst with Aite Group, a financial services consultancy. Current regulations and profit considerations would make it impossible for deposit-taking banks to make small, high-risk loans, Pratt says. But they could establish nonprofit subsidiaries that offer such loans.
“They could really make a difference, and it would help to put a dent in high-interest fringe lending, like payday loans and auto title pawns,” Pratt says. “I find microfinance terribly exciting. Here’s an opportunity to extend a credible lending model to millions of underserved consumers.”
This article appeared in the New York Times