Call for more info (216) 593-0402

Access to Small Business Capital

In the Opinion Section of the November 4th Wall Street Journal, Mr. Peter Wallison, a senior fellow at the American Enterprise Institute and best-selling author, wrote an article titled Bernanke and the Slow-Growth Crew.  I believe it was a thought provoking article in that Mr. Wallison is drawing a causal relationship between a slow economic recovery, which has averaged 2.2% over the past five years, to what he believes is an over-reaching Frank-Dodd Act signed into law in 2010.  Mr. Wallison draws a connection between the Act and lending restrictions on existing small banks and the formation of new banks as hurdles to the economic recovery and in particular small companies that create more new jobs.  Among a number of charges, Mr. Wallison cites a 2015 Goldman Sachs study that concludes, in part, “small businesses – which rely largely on small banks – have been unable to find the credit necessary for growth, while large firms have access to credit through the capital markets.”

looking at the cost of capital benefitsAs a business owner myself, a small business private equity investor and an advocate for entrepreneurship, I have seen first-hand the challenges small businesses have in receiving credit from banks.  Most banking officers will concede that their hands are tied by bank industry regulation, citing the Frank-Dodd Act, in making underwriting decisions.  For those of us that have the good fortune of working with entrepreneurs and small business owners, it is easy to agree with the causal relationship offered by Mr. Wilkinson because we see it on a regular basis.

I do want to take this discussion further, however, to include the newly approved crowdfunding rules.  I find it ironic that the government has stepped in to the financial markets in two different arenas, banking regulation and securities law, to correct what they perceive to be problems with existing regulation.  To me, the consequences have been that small businesses that used to rely on small bank loans for funding, which are relatively low cost in comparison to the high cost of crowdfunding, including sharing ownership of your business with third party investors.  There is no higher cost of capital than sharing ownership.  I am not going to delve into my previously published comments on crowdfunding, but will focus on the cost of capital and perhaps unintended consequences (although probably well-intentioned) of government overreaching with regulation.  The government has effectively made small business ownership more difficult and less rewarding by changing the cost of capital paradigm by shifting small business from small banks to small equity investors using crowdfunding.  Generally speaking, small banks will lend to small business at or around the “prime rate” which is a published benchmark rate widely used in the banking industry which is at a 3.25% annual rate today, plus 1% or 2%.  In private equity investments (crowdfunding), investors return expectations are typically over 30% annual rate.  This cost of capital is a major barrier in a small business’s ability to add capacity and create new jobs that will get America growing at a more robust rate and get wage growth out of neutral gear.

Now I believe that the financial services industry needs to have oversight and I also believe that small businesses need to have credit to grow, so my comments are not a categorical rejection of government’s important role in transparency and fairness which is the foundation of healthy financial markets and by no means are my concerns around crowdfunding an attempt at reducing capital flows to small businesses.  I am a strong advocate for both, but I believe the government needs to reconsider its approach in both the Frank-Dodd Act and new crowdfunding legislation.

Posted by: Jeffrey Kadlic A co-founder and managing partner at Evolution, Jeffrey has spent the past 15 years as an investor and private equity professional with a true passion for working with dynamic small businesses. @kadlic

Comments (0)

Leave a Reply

Your email address will not be published. Required fields are marked *

Please enter the following text into the form field below it