Credit Crunch for Small Business

A credit crunch could be on the way for small businesses - and it is crucial that they prepare themselves for the possibility. Banks, nervous about the prospect of more borrowers defaulting on loans, have been tightening their rules when it comes to lending money to consumers and major corporations. And industry experts say lending jitters may soon extend to small firms as well, making it harder for them to find loans.

In recent years, credit has been relatively easy to come by as banks aggressively pursued entrepreneurs, offering larger loans at cheap rates to untested companies. Most bank executives say that for now, they have neither toughened lending standards nor raised interest rates on loans to small businesses.

But banks say some businesses that received loans in recent years are falling behind on payments - and default rates are expected to accelerate. As a result, experts say some lenders are already tightening their lending criteria and they expect more to follow suit.

So small companies may want to think about ways to insulate themselves from the possibility of a credit crunch.

Here are some suggestions

• Pick a bank that caters to your situation
• Keep detailed and professional financial records
• Be prepared to put up personal assets like homes as collateral, which can make a big difference for young companies seeking funding

The Best Bank for You

One of the most important decisions small businesses face as they hunt for loans is which bank to turn to. Business owners should keep in mind how different types of banks evaluate loan applications.

Big institutions that promise speedy approvals or rejections of applications, generally rely on credit-scoring models based on the business owner's personal credit history. By contrast, community banks, credit unions and other smaller lenders often lean more heavily on their knowledge of the local economy and the would-be borrower's business model and track record of running or launching businesses.

Lease financing companies have been aggressive in providing low document leases – usually up to about $75,000, and can be great sources for equipment and asset financing.

Credit unions are nonprofit institutions owned by their depositors. Credit unions tend to make smaller loans than banks and have been making a big push to attract more small-business customers. In addition, entrepreneurs should look for lenders with programs aimed at specific types of small businesses: women, minorities, veterans. Of course, when applying for loans, it also helps to have an existing relationship with the bank.

Detailed Documents

While some banks have been hawking loans that don't require business owners to provide much financial documentation beyond recent tax returns, that's starting to change.

When applying for loans, small businesses should be ready to produce cash-flow statements, balance sheets, and even financial plans. Having it on hand is likely to impress bankers and could tip the scales in favor of getting a loan approved. Companies should consider hiring part-time, high level professional financial help to improve documentation and help present a professional image to bankers.

Collateral

Entrepreneurs in search of funding also need to be prepared to put their personal assets, like a home, on the line. But experts say that with home values stalling or falling in many parts of the country, business owners shouldn't count on that as the only collateral while banks get more skittish.

Bottom line…things will get tougher for small business financing, and banks will tend to favor companies that have their financial houses in order, that produce reliable and accurate financial statements, and that can demonstrate a deep understanding of their business model.