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The Pros and Cons of Easing Access to Credit
By: Karen E. Klein, Business Week
Friday, March 20, 2009

President Obama recently unveiled plans to spur lending to small businesses. Experts detail the benefits and drawbacks of taking on debt.

Over the past few weeks, President Obama has unveiled multiple plans for aid to small businesses, including lowering loan fees, increasing guarantees on government-backed loans, and buying up to $15 billion in Small Business Administration-backed loans. But will the new programs unfreeze credit as they are intended to do? And how can entrepreneurs take advantage of the warmer climate if they do?

Sanford Ehrlich, executive director of San Diego State University's Entrepreneurial Management Center, says the lending initiatives are likely to provide some relief, but he worries it won't be enough to help companies that are really struggling.

"Anything that will increase lending will be good for small business, but you have to be a fairly liquid small business to take advantage of this program. If you have too much inventory, too little cash flow, you're currently carrying debt that's been called, or balloon payments are staring you in the face, adding more debt to your current situation isn't going to help," Ehrlich says. "So many small businesses are in serious trouble that the number this will help will be limited."

Take Advantage of the Downturn
Ehrlich says he would have preferred to see government increase its spending in the SBA's Small Business Innovation Research or Small Business Technology Transfer programs. With the overall decline in wealth, he says, there's no longer much private investment money for the innovative, high-technology startups that often have an outsize impact on high-wage job growth.

If, however, small business owners can position themselves to take on new debt to fund future growth, Ehrlich says, they should begin looking for credit as the Obama plan goes into effect. "Companies currently in decent cash positions should consider plowing money back into their marketing and branding efforts, buying competitors, and accumulating more market share in this economy," he says.

But Ehrlich cautions entrepreneurs struggling to keep their heads above water not to think of loans as life preservers. "If your company is going under, do a realistic evaluation about whether you need to liquidate. Don't take on more debt just to keep treading water."

Time to Expand
Maria Minniti, a professor of entrepreneurship at Southern Methodist University's Cox School of Business, agrees. Companies in good financial situations are likely to benefit from increased access to credit under Obama's plans, particularly when combined with a market in which costs are down for human capital as well as commercial space. "This may be the time to upgrade your location or hire some fantastic talent," she says.

And would-be entrepreneurs with good credit scores might find this a good time to borrow some funds, she adds. "Small businesses, especially young ones, tend to operate on a tight budget, stretching earnings from year to year. If you've operated on a budget and you're holding some reserve, this may be the time to borrow and make improvements or expand."

Daniel Meyerov, a small business consultant and founder of, says companies looking for new credit should approach lenders by emphasizing the part they'll play in economic stimulus. "Banks won't want to lend to small businesses that are going to hold the money and try to survive through the wilderness," Meyerov says. "They will want to see it invested in the economy in a way that will support surrounding businesses in the supply chain."

Filling out Forms
A compelling loan application will include detailed plans for how you'll use the money—along with forecasts of results, he says. Also make sure your paperwork is completed properly before you deliver it to a lender.

"This is often an issue with small businesses, and it affects their credibility and accountability," says Meyerov. "If you're unsure and you fill out the paperwork wrong, it'll go into a very large pile marked 'more detail needed' that can sit on a desk for a very long time. Position yourself properly, have your documents ready, and if you're a viable business, you'll get access to capital sooner rather than later."

Demand for loans has dropped in 2009, according to the U.S. Treasury, perhaps because many companies are pulling back on spending or fear they wouldn't get a loan if they applied for one. But demand is likely to increase if banks feel more comfortable lending under the new government guarantees, says Minniti.

Drawbacks Nonetheless
While she commended the Obama Administration for putting a spotlight on small business, she says she is wary of the idea that government—not the free market—may play a greater role in determining which companies get loans. "Economists like myself tend to believe that the market incentive structure does the best job of selecting and channeling financial flow to the right places," she says.

Minniti worries that with higher loan guarantees and government providing a secondary market for small business loans, bankers will be tempted to abandon their strict monitoring role in lending. "In spite of their best intentions, the government's attempts to monitor and implement these programs correctly will add to a huge bureaucracy." she says. "Will a large government plan do a better job than the market would? It's tricky to work that out."

Dan Mica, chief executive of the Credit Union National Assn. and former U.S. Representative from Florida, agrees that creating a small business "lending bubble" would be a mistake. "You have to draw that line very carefully," he says, "but people who do lending for a living are very good at making the distinction between businesses that need extra help without being imprudent in their decisions."

Trying to Raise the Ceiling
Mica, whose organization represents the nation's 8,000 credit unions and their 90 million members, is working to get laws changed that cap credit unions' ability to lend to small companies. "Our credit unions are the best-capitalized financial institutions left in America, and we could put $10 billion into the economy almost immediately," he says.

Mica spoke to Obama adviser Valerie Jarrett, and his chief counsel spoke briefly to President Obama, at the small business press conference on Mar. 16, Mica says. Under current law, credit unions can use up to 12.25% of their total assets on small business loans. But most have reached that cap and would like to extend more loans to small businesses, where he says credit unions have default rates of less than 2%.

"We have a record of lending to small companies, and we know how to do it," Mica says, noting that Senator Charles Schumer (D-N.Y.) is planning legislation to raise the cap on credit union lending later this year.

Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues.