Alternative financing helps 'un-bankable' entrepreneurs gain lift off

By: Matthew Kish - Aug 04, 2016
Source: Portland Business Journal
In the wake of decreased small business lending entrepreneurs are finding new ways to get their businesses off the ground.

Lisa Ramirez threw a house party for potential investors June 7. A hundred showed up. Roughly 30 wrote checks. Despite the buzz, she says her startup, Two Tongues, can’t get a loan.

“I’m not in the financial position to get a $50,000 loan from a bank,” she said. “They don’t give money to people like myself who have student debt and don’t have a home. I believe myself to be un-bankable. A lot of people trying to build startups are.”

Ramirez isn’t letting the lack of traditional financing derail her. Small business lending in Oregon may not have returned to pre-crash levels, but Ramirez and other entrepreneurs are turning to new methods to get businesses off the ground. Some are succeeding. But critics worry pitfalls await as online lenders fill some of the void. They also say lack of capital for small businesses remains a headwind on the Oregon economy.

Across the state, small business lending, in dollar volume, is down 16 percent since the crash. Lending to bigger businesses is up. Commercial real estates loans have climbed 12 percent in Oregon since 2008. Commercial and industrial loans, a type of business loan for established businesses, are up 11 percent.

Experts say the dip in small business lending reflects, at least in part, the hollowing out of the state’s community bank landscape. Such banks are known for working with mom-and-pop businesses.

Forty banks called Oregon home before the crash. The state only has 25 today. Some perished from betting too heavily on real estate. Others got acquired. Those that remain are also working under tougher oversight from regulators.

“The loss of community banks is probably the reason capital is a little bit more restricted,” said Robin Wang, executive director of Portland-based Albina Opportunities Corp., a nonprofit community lender that serves businesses unable to get traditional financing.

Buffalo exchange for the LGBTQ community

A year-and-a-half ago, Ramirez came up with the idea for Two Tongues. She wants to build the company, which for now only sells online, into a sort of Buffalo Exchange for the LGBTQ community.

She came up with the idea after a late-night shopping trip to the men’s department of a traditional retailer.

“I couldn’t think of a single space where I could get something that could fit the LGBTQ style,” she said. “It’s a different fit. At that point, that’s when I said I’m going to make this happen.”

Instead of walking to the nearest community bank and getting a line of credit, she turned to Hatch Oregon.

Hatch is part business accelerator and part launch pad for small public offerings for businesses like Two Tongues.

“We focus on teaching people, ordinary folks, how to start companies,” said Executive Director Amy Pearl. “One of the challenges ... has been access to capital.”

Hatch has been around for about 12 years. It burst into headlines a few years ago when it helped draft Oregon’s crowdfunding law, which allows mom and pop investors to write checks to local businesses.

Previously, securities laws prohibited such practices in order to protect unsophisticated investors.

“As we started helping entrepreneurs through this mess of finding funding, we realized the choices were all bad,” Pearl said. “If you’re starting a social enterprise and starting something dramatically risky, you’re not going to get a loan from a bank. You’re also not going to attract an angel (investor) if you’re not something they can flip. We needed to find a way to share the risk.”

Hatch launched its first mini-public offering in January 2015. Since then it’s hosted around 30. It gets a new batch every quarter. Some have been wild successes, such as Red Wagon Creamery, the Eugene-based ice cream company that raised $120,000 and has already gotten its products into Fred Meyer.

“Sometimes people come to me and say they’ve been turned down by eight banks and say they’re ready to quit or they’ve mortgaged their home,” Pearl said. “That is what most entrepreneurs do, mortgage their home.”

The pitch resonated with Ramirez.

“When I heard about Hatch, I thought, this is brilliant,” she said. “I don’t want a large institution to benefit from my startup.”

Through Hatch, Ramirez hosted the June house party. She now has 47 investors. She’s raised $7,675. If she raises $15,000, she’ll open a pop-up store on Alberta next summer and build a mobile store she can take to Pride events in other cities. If she raises $70,000, she’ll open a bricks-and-mortar location.

Options abound, just not banks

Hatch is one of a string of options that have popped up in the wake of the crisis.

Craft3 does community loans. Mercy Corps Northwest, which is known for humanitarian work abroad, offers a series of classes and small grant programs for entrepreneurs. Albina Opportunities Corp. works with disadvantaged communities. Portland also ranks high on lists of cities known for crowdfunding.

“We have more pools of capital available now than ever,” said Stephen Green, a veteran small business banker, economist and entrepreneur who most recently worked as community director for Elevate Capital. “People have access to things that they never had before.”

Zenger Farm used a small loan from Craft3 to help finance a $2.3 million real estate project. The nonprofit urban farm raised donations to pay for the entire project, but some of the checks won’t arrive until 2018. Instead of waiting to get all the cash, it got a $270,000 bridge loan so it could start construction. As the final checks roll in, they’ll be redirected to Craft3, which offers various loan programs, some funded by community members.

“Without the loan from Craft3, we would not have had the cash to pay the builders,” said Executive Director Mike Wenrick. “It bought us time. It gave us the capital we needed.”

American Procurement Services works with international aid groups like the United Nations. CEO Washington Oyoo turned to Albina Opportunities Corp. in 2014 after unsuccessful attempts at getting a bank loan. He got a $100,000 credit line, enough to fund the company’s first orders.

“We didn’t know what to do,” he said. “Every big bank refused to give us (credit) even though we had some purchase orders. (Albina Opportunities Corp.) gave us a (financial) foundation.”

The company employs eight with offices in Corvallis and Delaware. It’s since graduated to bigger lenders.

Albina Opportunities Corp., founded in 2008, is a nonprofit lender that makes small business loans ($20,000 to $250,000) to businesses in disadvantaged communities. The money comes from the government, as well as institutions and wealthy individuals.

“We’re not regulated like banks,” said Executive Director Robin Wang. “We can be much more creative with how we structure the loans and take on risks that banks beholden to the FDIC can’t.”

For example, a low credit score typically disqualifies a business owner from getting a bank loan. But what if the shoddy credit score resulted from an unrelated medical bankruptcy?

“We look at the business as a whole,” Wang said. “If there’s a way we can get to yes, we get to yes.”

Albina has funded about $5.5 million in loans to a total of 70 clients. It has a roughly $3 million loan book. It’s only had three defaults.

“Considering the nature of the risk, I think that’s a pretty good story,” he said.

While entrepreneurs are excited to have more options, some worry about the rise of predatory lenders, especially online.

“Some of it borders on predatory,” Wang said. “It’s the business equivalent of paycheck lenders.”

Small business lending drops

The uptick in alternative financing comes against a backdrop of decreased loans to small businesses.

Federal data shows the dollar amount of small business lending in Oregon is down 16 percent since the 2008 crash. Loans to larger, more established, businesses are up, a sign some banks are still licking their wounds from the excessive risk-taking that fueled the crash.

“That’s one of the new realities of where we’re at post-recession,” said Green, who’s worked on both sides of the small business lending-fence. “A number of the bigger banks have re-calibrated how they do small business lending.”

Green worked as a small business specialist for U.S. Bank. He also worked for Albina Bank. He currently works as an adviser to Elevate Capital, a venture firm that funds minority-run startups.

Another reason for the drop in small business lending? Oregon has fewer banks. There were 40 banks based in Oregon when Lehman Bros. toppled and sparked the 2008 crisis. There are 25 today.

“Just from a competitive perspective, more banks equals more choices,” said Albina’s Wang. “We give seminars to business owners all the time. One of the things we tell them is shop for a loan.”

Importantly, most of the banks that vanished were smaller banks, places where it was easier to form a relationship with the CEO or chief lending officer and avoid the unforgiving credit-scoring matrix that defines the loan process for big banks.

“They’re going to be by nature more flexible and generous and supportive of community-based loans,” Wang said. “If you look at the portfolio for Albina Bank and Wells Fargo, they’re going to be vastly different. The loss of community banks is probably the reason why capital is a little more restricted, particularly in rural communities. Maybe Portland isn’t impacted, but if you go to eastern Oregon or the coast, a community bank can play such an important role in financing the businesses in those communities.

While small business lending is down, SBA lending is up (see Page 18).

“Historically, as the economy improves, SBA lending levels off,” said Scott Bossom, a lender relations specialist in the SBA’s Portland office. “The idea is that as businesses are doing better, lenders don’t need a guarantee to do a deal. You still have some of that.”

Green said capital availability is one of a slew of issues that need to be discussed.

“The last thing I want to do is blame banks,” he said. “That’s not the case. It’s an easy scapegoat. It’s just the tip of the iceberg, the thing you see above the water. The true problems are the below-the-water things.”

He said Portland stumbles because it doesn’t have an Office of Small Business or some other logical starting point for entrepreneurs. Many never get started because it’s difficult to know the first step. And when they do there’s not enough mentoring options.

“Access to capital is like the No. 4 reason businesses go out of business. No. 3 is uncontrolled growth,” he said. “No. 1 is management.”

Digging deeper into the data

Experts say the FDIC data doesn’t tell the full story. Banks, after all, only make a profit when they loan money at a higher interest rate than they pay depositors.

“Overall, small business is still a pretty active category for community banks,” said Jim Bradshaw, a 33-year veteran and senior bank analyst for Bridge City Capital.

They say new options, like crowdfunding, have reduced demand for small business loans. They also note the stock market is booming. That makes it easier to borrow money from friends and family, the first stops for most entrepreneurs.

Irene Matyas manages business banking in Oregon and southwest Washington for Wells Fargo, the No. 1 small business lender in the country, when measured in dollars loaned, and the No. 2 SBA lender in Portland.

Specifically, Matyas’ division works with businesses with between $5 million and $20 million in annual sales, generally the third step on Wells Fargo’s business banking ladder.

Like most banks, Wells Fargo starts working with a small business when it opens accounts — checking, savings, lines of credit — at a branch. As businesses grow, they get steered to resources like Albina Opportunities Corp., which Wells Fargo helped fund with $375,000 this year. Wells Fargo also has other programs for small businesses, such as its SBA division.

As businesses grow, they graduate to Matyas’ business banking team. They graduate again when they hit $20 million in sales and get passed to the bank’s corporate banking team.

Matyas said Wells Fargo’s lending standards haven’t changed.

“For most banks, and for the SBA, the general consensus is (small businesses) have to be in business at least three years or more, and at some point they need to have turned a profit. They need to generate enough cash to pay back loans,” she said. “These have been very standard underwriting guidelines for many, many years. If there’s a decline in loans it’s because fewer companies are able to qualify.”

Matyas said Wells Fargo welcomes non-bank lenders that are helping launch startups.

“As those businesses become successful, they’ll turn to us for more traditional loans and banking resources. Once they’re in that realm, it’s definitely at a lower cost to them.”

But even some established entrepreneurs said business lending is so PowerPoint-driven it forces some amazing business ideas to stay on the sidelines.

Kevin Cavenaugh, co-owner of 24th and Meatballs, said the restaurant recently got an $85,000 loan to open a location in St. Johns in September. It’ll be the restaurant’s second location, after one in the Kerns neighborhood.

“You’ve gotta be a millionaire to borrow $100,000,” Cavenaugh said.

Cavenaugh also develops commercial real estate through his firm Guerrilla Development, which he said makes his balance sheet able to pass muster with a bank.

“At the end of the day, banks look at the owner’s balance sheets,” he said. “That’s a shame. There are restaurants with better menus and business plans. That doesn’t matter as much as the financial capacity of the signer. It means there are fantastic businesses that we’re not going to see that can’t get over the starting blocks.”