How Microlending Helps Small Businesses Grow
If you have applied for a business loan recently, you understand how difficult it is to qualify for a business loan. The truth is that most lenders aren’t willing to risk their profits by giving a loan to entrepreneurs who don’t meet certain requirements.
Lender stay in business by only lending to borrowers who demonstrate a strong likelihood to pay back the loan based on certain criteria found in their financial information and credit history.
To alleviate this problem, microlending serves as a way to provide loans to those who would not otherwise access to loans.
Compared to traditional lending, microlenders take on the risk of offering loans without collateral. Borrowers can range from indigents to entrepreneurs with poor credit history.
What Is Microlending?
Microlending reflects the increasing growth of the peer-based economy that helps entrepreneurs gain access to capital.
Microloans are small loans issued by individuals instead of traditional lenders such as banks. Lenders can contribute to a single loan or spread out their contribution to cover a portion of several loans.
Lenders can extend a loan to borrowers who either have poor credit history with traditional sources, or borrowers who do not have access to traditional financing due to their geographic location.
Microloans are ideal for two major scenarios: to help individuals in serve two main purposes. First, microloans help less fortunate individuals in economically underdeveloped countries start small businesses. Second, microlending helps entrepreneurs who do not have access to traditional loans due to poor credit, or other financial reasons that categorize them as ‘high-risk’ to traditional lenders.
Assist Borrowers In Economically Underdeveloped Countries
Microlending is used to help borrowers with in economically underdeveloped countries who do not have access to traditional methods of financing.
Similar to the process associated with traditional loans, borrowers must provide the purpose for the loan, and a business plan detailing its operations. The borrower must provide personal information as well as a bio for consideration.
Help Entrepreneurs With Bad Credit
The second purpose is to lend to entrepreneurs who either have poor credit or seek small loans below the bank minimum requirements.
How Does Microlending Work?
Multiple lenders can fund either a single microloan or portfolio of microloans in order to minimize the financial impact and diversify the level of risk in the event of default.
Once the loan has matured, lenders get interest on their loan and repayment of the principal. Since the risk of default is imminent, the high interest rates make microlending an intriguing risk for some investors.
How Do Microlending Companies Make Money?
Microlending companies generally earn a profit by charging fees to set up and maintain loans. These fees are usually added to the borrower’s interest rate, which is one of the many reasons that interest rates are so high for microloans. Microloans are much riskier than other loans since there is no collateral in the event of default. The high rates ensure that all parties lend and borrow
The Pros And Cons Of Microlending
There are many attributes that make microlending a positive venture for lenders and borrowers alike, such as economic growth, opportunities for entrepreneurs, and a high return on investment for lenders.
Positive Economic Growth Around The World
Microlending has steadily increased in popularity due to the immediate gratification and sense of connection it brings to borrowers and lenders. Lenders who can afford to lend out their savings get a nice return on their investment while knowing that they are helping borrowers reach their goals. Borrowers get access to funding that they would not have received from traditional lenders. When managed correctly, microlending is a win-win situation for all parties.
Lenders Earn High Interest Rates
Because interest rates are high, lenders stand to benefit greatly if they exercise discretion in their lending. Lenders can select which loans they want to fund, and they can also request more information about the borrower before making a commitment.
Share The Risk With Other Lenders
Because of the uncertainty surrounding borrowers, lenders often invest a small amount for each microloan, but still fund portfolios containing multiple microloans.
As a result, borrowers may discover that their loan actually belongs to several lenders to equal the total loan amount. Spreading the risk across multiple loans gives lenders peace of mind that the portfolios will be safe even if a couple of the loans default.
Because just one microloan carries a huge risk, lenders often allocate their investment across a portfolio of several microloans. Therefore, most borrowers will discover that more than one lender will fund their loans. Allocating the risk across various loans will protect lenders against losing their portfolio if a couple of their loans default.
Understand the Risk And Plan Accordingly
Traditional lenders ensure profits by lending to borrowers who demonstrate a strong likelihood to pay back the loan. While the same is not true for microlenders, they can still take steps to minimize the risk of default.
Borrowers are rated based on financial data such as their credit history, background check results, and repayment history for previous microloans, if applicable.
Remember, the lender gets to decide whether to fund the loan, whether it be for personal reasons or doubts about the borrower’s ability to pay back the loan or carry out the business plan. In certain cases, loans may be inadequately funded due to the lack of lenders willing to make a contribution.
While microlending can help entrepreneurs get loans and lenders earn high interest rates on their savings, there are some risks and downsides that must be seriously considered before entering into an agreement.
High Risk In Event of Default
Why is microlending so risky? Unlike their traditional counterparts, micro loans are usually not supported by collateral. While lenders run a high risk of recovering little to nothing in the event of loan default, lenders are made aware of the risks before they lend money. Lenders face a dilemma, but they know the risk going in. Remember, if the lender does is suspicious of the borrower’s intentions, the lender can elect to not fund that specific loan.
High Interest Rate For Borrowers
While the risk is higher than a traditional loan, it is still better than no loan at all. In addition, it is much better than high rate personal loans with impossible repayment terms. Even the candidates with the best financial history are still offered interest rates higher than traditional loans.
Microlending companies such as Prosper show interest rates ranging from 6% for borrowers with the best credit to 31.9% for borrowers with high risk factors.
If the investor feels that 6% is a safe risk for extending a loan, the loan may give a better return on investment compared to other methods of lending.
Since financial institutions find these borrowers to be high risk, borrowers turn to individual lenders to fund microloans.
The Bottom Line: Microlending Helps Everyone
With microlending increasing in popularity, small businesses will get better opportunities to compete with larger businesses by having access to the same type of loans as their more fortunate peers. Private lenders with enough money in their savings accounts can set the parameters for lending and earn a competitive interest rate while helping entrepreneurs fulfill their dreams.
Securing financing for small business venture does not always turn out easy, according to the Small Business Administration (SBA). Native Americans face the same predicament that small business owners and minority entrepreneurs. Business News Daily writer detailed how startups find it difficult to obtain small business loans because of the following reasons:
- Negative Credit History – Lenders rely mainly on credit history to determine the borrower’s paying capacity.
- Restricted Cash Flow – Lending facilities also look at the business owner’s cash flow to pay back loans.
- Business Plan – Banks and lending firms look for a systematic, comprehensive, and quantitative business strategy as a prerequisite for loan processing.
- Organization – The business must demonstrate organized operations and documentation.
Entrepreneurs who fail to meet the criteria as mentioned above will find it hard to obtain loan approval.
Small Business Grants
BIzfluent states that Native Americans can look forward to small business funding from federal and state governments. Some public and private entities also offer grants only for Indigenous Americans. Eligibility requires the applicant to become a member of any recognized tribe in the country.
The First Nations Development Institute authorizes endowments for economic development given directly to the tribes concerned or Native American non-profit groups. It created a Native Asset Building Partnership Coalition offering investment subsidies to promote businesses of home-grown citizens.
On the other hand, the United States SBA offers loans instead of grants although the agency allocates capital for the so-called Native American Micro-Enterprise Business Services. The SBA does not provide funds for expansion but conducts executive and specialized training courses to qualified applicants.
The Department of Agriculture conceived the Rural Business Enterprise Grants to finance business ventures of legitimate Native American tribes as well as make available employment opportunities. Only officials of certified ethnic groups can apply for RBEG funding which ranges between $10, 000 and $500, 000 without any cost-sharing precondition. Local and state RBEG offices receive applications every year although submission dates vary according to state.
The United States Commerce Department provides an assortment of grants solely for job creation with indigenous Americans as beneficiaries. Tribal governments and their constituents, as well as companies that conduct business with these natives regardless of the location of these enterprises, can apply for the subsidy. The category of grants includes tourism promotions, economic development, and infrastructure programs.
One of the US Department of Health and Human Services (Office of Children and Families) known as the Administration for Native Americans offers opportunities in the areas of socio-economic development, sustainable employment, and asset-building for Native Americans. The ANA funding ranges from one up to five years and includes technical training.
Free Assistance from Office of Native American Affairs
The Office of Native American Affairs conducts technical assistance programs for free to help companies with a variety of business disciplines in marketing, financial analysis, compliance, contract management, strategic planning, and others.
Interested parties can contact the following organizations:
- Cherokee Nation (Tahlequah, Oklahoma) – Combine training with executive counseling for entrepreneurs in sales, marketing, financial management, and product management.
- Oregon Native American Business and Entrepreneurial Network (Portland, Oregon, and Tulsa, Oklahoma) – Provide Peer Monitoring and Entrepreneurial Exchange Program concentrating on Indigenous American small enterprise in Texas, Oklahoma, and New Mexico states.
- Native American Development Corporation or NADC (North Billings, Montana) – It offers pre/post technical aid for native-owned and managed small-scale enterprises as preparation for government contracting which adopts the SBA procurement program and other state/federal platforms.
- Indian Dispute Resolution Services or IDRS (Plymouth, California) – The IDRS carry out entrepreneurial training courses and imparts technical support for tribal members all over California, Oregon, and Nevada. Workshops include accounting specifically Quickbooks, financial planning, business plan formulation, computer literacy, and negotiations.
Dilemmas of Native American Entrepreneurship
Entrepreneurship represents one of the remedies to financial hardships that majority of American Indians face. Unfortunately for them, specific factors hinder their progress primarily because of issues such as poverty, work experience, and inadequate formal education. Majority of Native Americans many of whom do not have jobs live in destitution. This condition affects their capacity to become eligible for loans and capability to make use of assets in self-finance. Lack of academic and employment experience prevent them from becoming entrepreneurs.
Most of these tribes still live in remote reservations which remain far from market hubs making it harder and expensive for a few skilled natives to serve trading markets. The absence of Internet access, as well as telephone services, further aggravates their condition. Inadequate communications systems make it more difficult for Indigenous American entrepreneurs to coordinate with mentors, network with stakeholders, and explore their customer base.
Discrimination and Repression
Historically, American Indians have always borne the stigma of racial bias and oppression by their countrymen. This situation and years of inequality have somehow affected their positive mentality and ability to develop their skills and engage in worthwhile undertakings. In fact, favoritism against minority business owners still proliferates in lending practices. Only a genuine change can drive Native Americans to seek better opportunities.
At the same time, Kaufmann research studies pointed out that the low rate of entrepreneurship in Indian reservations and among native tribes lead to less exposure to entrepreneurial prospects. Native Americans have fewer mentors to learn from which represent among the primary factors in the entrepreneurial boom.
Rules, Risks, and Structure
Research also revealed small business proprietors would less likely launch or start expansion with the belief that standards or regulations may not change for the better sooner or later. Tribal governments demonstrate inconsistencies and do not maintain standardized regulatory processes and benchmarks for startups.
The factors of an insufficient history of the enterprise together with tribal government unpredictability contribute to the downfall of the prospective entrepreneur or small investors. These potential business operators find it confusing to figure out results expected from them. Speculators who fail to foresee the regulatory atmosphere for possible investments find isolated federal reservation risky places for investment activities.
In spite of everything, the United States federal government, state governments, and non-profit institutions continuously implement programs and give out financial support for minority enterprises. The writing of grants, submission of applications, documentation, and approval process takes time. The benefits of free funding make the waiting time and efforts worth working for in the long run.
According to the Small Business Administration, minorities come in the following demographic groups:
- African American
- American Indian
- Native Hawaiian
- Pacific Islander
Given this position of the government, Native Americans can still look forward to prospects in entrepreneurship and a slight chance to enhance their lives despite the challenges as well as the unfortunate position of today’s minorities.
Author: Jane Meggit has been writing for a reputable newspaper chain during the last two decades. She earned a Bachelor of Arts degree in English from the New York University and Associate of Arts degree from the American Academy of Dramatic Arts also in NYC.
Author: Paula Fernandez, a writer based in New Jersey finished her Bachelor’s in English and Master’s Degree in Education. She worked as director for an academic service learning and community outreach facility for almost ten years. Her experience includes corporate communications, public relations (non-profits), and publishing.