In a recent piece in New York Times, Ian Mount poses a question whether it is morally and ethically defensible for small business owners and entrepreneurs to be forced to bet their houses to get financing for their business. Since I am one of the stories profiled in the article, it goes without saying that this is a question that I have wrestled with myself over the course of my entrepreneurial journey.
(If you cannot read the NYT article due to paywall issues, it can also be read at CNBC.com)
I forwarded this article to one of the bankers that I was negotiating my loan with, back in the year 2008. He immediately emailed me back and we set up an informal chat over coffee. This banker is the VP of Business Banking for one of the major US banks in Detroit market and in his position he deals with entrepreneurs and lending all day long. He confirmed to me that the experiences described in this article are spot on and perhaps there IS something wrong in the system in this country.
For example, he picked up on the statement in the article that “The 2 kinds of people: Entrepreneurs with ideas and no home equity, and people with lot of home equity and no ideas, are both out of luck in the current system for business funding”
What Should be the Government’s Role in Encouraging Small Business?
The SBA loan program, through which the US government aims to encourage and fund small businesses, is flawed in at least two respects:
- Legally an incorporated business and the owner are two separate entities and most business laws insist on not mixing up the business and owner personas and assets. In this light, it is incomprehensible that SBA requires personal property as a collateral for business debt
- The SBA program does not work for people with solid ideas but no assets to pledge leaving a large portion of potential small business owners in lurch
As a result, the SBA program actually discourages new small businesses from starting up in the periods of economic distress such as today, when the new business activity is sorely needed to pull the country out of recession, and when the aspiring entrepreneur is short on home equity.
The Government Should Back Solid Business Plans Without Collateral
Not every business qualifies for the private venture capital backing. Perhaps that is as should be. VCs are looking for high payoff situations, and they are not likely to be interested in helping an aspiring entrepreneur set up a new restaurant around the corner. These are small deals in their book and the returns are not worth it.
But there is something in the Venture Capital model that is worth emulating: review the business plan, bet on the jockey, hold them accountable and finally run your investments as a portfolio with full expectation that a large number of ventures will fail but the ones that succeed make up for the failures and some more.
In short, understand the risks and rewards and make an informed bet and focus on portfolio returns while trying to make each business work out.
VCs do want the entrepreneurs to have a skin in the game. Any lender will and should. But they do not demand that you need to put up your personal property as collateral. Treat business as business and keep the personal property out of the picture. Another reason to keep personal and business finances separate is for the liability issues and co-mingling business and personal credit may be risky in another way as well. It may be a good idea to have LifeLock monitor your business credit to provide protection against credit and identity theft.
The problem is that main street businesses have no access to Venture Capital, and this is where the federal programs such as SBA guarantees come into play. I really think that the Government should take some risk, following the VC approach, and find ways of backing solid business plans with unsecured funding. New mechanisms could be set up for this, perhaps some public-private risk sharing is in order. As a portfolio, the feds could make better risk adjusted returns, but the gravy is the real entrepreneurial surge in the country which will lift all boats.
I bet the cost of doing this will be just a fraction of the money the US government has spent to bailout AIG and the other financial firms.
It is a better use of tax payer money and the government will be doing its job, which is to lubricate the economic engine of the country so the welfare of its citizenry is enhanced.
What do you think?