OCTOBER 1999

ISSUE 2

FINANCING PRODUCTS ... since inception, o identify new financing tools that uals producing goods and providing Tcan help low-income entrepre- services in largely informal microenterprise neurs obtain the capital they need to economies, where traditional banking start or expand their businesses, services are not available. programs in the FIELD selected this critical issue as However, practitioners soon one of its first grant-making areas. In found that although microentrepre- U.S. have struggled June 1999, following a Request for neurs in the United States express a Applications process, five organiza- to reconcile the desire to access credit, loan demand tions were selected to receive two- in this country has been much lower year, $100,000 grants to experiment than expected. Indeed, since incep- strong desire for with new ideas and approaches for tion, microenterprise programs in the providing business capital to the poor. capital expressed U.S. have struggled to reconcile the The purpose of these grants is to strong desire for capital expressed by advance the scale and quality of the by low-income low-income entrepreneurs with the microenterprise field’s efforts to help difficulties in lending to these low- entrepreneurs with microentrepreneurs access capital. wealth, often inexperienced and often FIELD chose to invest in demonstra- risk-averse business owners. the difficulties in tion grants to microenterprise pro- The relatively slow growth in loan grams because its guiding principle is portfolios of U.S. programs has been lending to these that practice advances more rapidly documented by several sources. In when leading practitioners have the low-wealth, often 1994, for example, only one of the opportunity to test new ideas, reflect seven senior agencies included in the on the results with their peers and inexperienced and Self-Employment Learning Project share their findings with others. (SELP) made more than 85 loans.1 often risk-averse This FIELD Forum presents the rationale behind this grant cluster, 1 Elaine Edgcomb, Joyce Klein, and Peggy Clark. business owners. profiles the grantees and the projects The Practice of Microenterprise in the U.S.: Strategies, Costs, and Effectiveness. Washington they will undertake and describes plans D.C.: The Aspen Institute, 1996. for future learning from these efforts. The Issue icroenterprise development pro- Microenterprise Fund for Innovation, M grams emerged in the United Effectiveness, Learning and Dissemination States in part because of the strong experience of microfinance efforts in The Aspen Institute developing nations. These efforts One Dupont Circle, NW • Suite 700 found a strong demand for credit Washington, DC 20036 among the many low-income individ- Phone: (202) 736-1071 Fax: (202) 467-0790 email: [email protected]

BUSINESS FINANCING PRODUCTS FOR THE POOR The 1996 Directory of U.S. Microenterprise • Microenterprise lenders have continually Programs 2 found that the 51 peer lending struggled to increase loan volume while programs surveyed averaged 42 loans in maintaining credit quality. Most lenders 1995, while 163 agencies providing individ- have experienced periods of high delin- ual loans averaged 29 loans in that same quency and/or staff turnover. These, in year. And, of the 28 microenterprise pro- turn, affect the rate of new originations grams funded by the Charles Stewart Mott as staff resources are diverted from serv- Foundation, more than half made fewer ing new loan clients to addressing prob- than 30 loans in 1995. Only five programs lem loans, implementing more stringent made more than 100 loans per year. borrowing and underwriting require- The relatively small numbers of loans ments to reduce delinquency, and, in made each year are mirrored in the relative- some cases, training new staff. ly small microloan portfolios held by • Peer-lending programs have faced microenterprise organizations. At the end of challenges in forming and maintaining 1995, one-third of the microenterprise pro- groups. Because in the group model, grams funded by the Mott Foundation had microentrepreneurs can only borrow less than $100,000 in outstanding loans; 89 through the group, problems with the percent had less than $500,000. The SELP peer group affect the rate of loan origi- agencies had similar experiences in 1994, nations. with average loan portfolios for the year • Perhaps most striking, programs have ranging between $156,000 and $503,000. found large numbers of clients who The small scale of loan activity among elect not to borrow — choosing only to microenterprise programs raises two concerns. receive technical assistance or training, Foremost is the issue of whether prospective or to participate in a peer group with- microentrepreneurs are receiving the financing out borrowing. Data from SELP’s 1999 they need in order to launch and operate their Directory indicates that only 11 percent businesses. of the clients of microenterprise pro- In addition, the long-term sustainability grams receive loans from the program. of microenterprise credit activities is inextri- In struggling with the challenge of low cably linked to their ability to cover at least loan demand, microenterprise programs a portion of their operating costs through explicitly targeting low-income customers interest and fee income. The level of cost have discovered certain characteristics of recovery is tied to the scale of the loan port- low-income borrowers that affect their will- folio. The programs in the U.S. that have ingness and ability to take on credit. These made the greatest strides in moving toward include: self-financing of their lending programs are • Risk-aversion. Many low-income bor- those that have achieved a significant level rowers are highly risk-averse in their of lending activity. attitudes toward borrowing. Given their There are a number of reasons for the precarious personal financial slower-than-anticipated growth of microen- situations, they often are concerned terprise loan programs in this country. They about taking on debt. Microenterprise include the following: program staff often counsel their lower- • The loan preparation and underwriting income borrowers to minimize indebt- process generally takes far longer than edness by starting their businesses on a originally envisioned. smaller scale, and by seeking ways to

2 C. Alexander Severens and Amy J. Kays, published by the Self-Employment Learning Project of the Aspen Institute in con- junction with the Association for Enterprise Opportunity. 2 reduce the need for start-up capital. • Is it best to use a While these approaches make sense for “stepped” lending individual clients, they also affect the rate at approach to deal Indeed, the industry which program loan portfolios can grow. with both the risk • Poor or no credit history. Program clients aversion and poor continues to with poor or no credit history can find credit histories of that the underwriting process is delayed, many borrowers? confront as staff or peer group members seek to Or are larger ini- understand the reasons behind the credit tial loans prefer- methodological problem and determine how that should able because small affect the decision to extend credit. loans often lead to questions about • Access to other sources of credit. Banks and small businesses other lending institutions increasingly that have difficulty how to best meet have begun marketing to small business garnering adequate market share or owners and low-income borrowers. the financing needs Increasingly, microentrepreneurs perceive generating signifi- cant enough credit cards as an alternative to microen- of low-income terprise lenders. In addition, microenter- income to support prise programs often find that their most a family? entrepreneurs. credit-worthy borrowers are able to access • Do low-income more traditional lending sources, leaving entrepreneurs really them with the riskiest and hardest-to- need access to serve borrowers. equity (or equity-like) financing, rather • Lack of equity capital. While microenter- than debt? Or does the use of equity prise lenders have long recognized the instruments potentially reinforce a “grant lack of equity among their borrowers and mentality” among people who may have have used nontraditional collateral to come to rely on welfare? secure loans, the lack of capital can be • Can microenterprise lenders effectively problematic when a microentrepreneur serve borrowers with poor credit histories? faces lower than projected sales and has What types of lending strategies work no excess resources to draw on to make well for them? loan payments. That has led practitioners • Is credit from microenterprise programs to consider the value of adding equity important or are other loan sources readily products to the range of financing available today? options they offer to customers. For a number of reasons, addressing the issue of demand for business capital among The Challenge the poor is important today. First, in-depth lthough the phenomenon of low-loan interviews conducted with microentrepre- A demand and the characteristics of low- neurs indicate that features of currently income borrowers have been acknowledged offered loan products inhibit willingness and for some time, the field clearly needs to devel- ability to borrow. Moreover, when microbusi- op more financing products and delivery sys- nesses owned by low-income entrepreneurs tems to address those issues. Indeed, the remain viable, they play a very significant role industry continues to confront methodological in a family’s ability to move out of poverty. questions about how to best meet the financ- Building a strong business presumably will ing needs of low-income entrepreneurs. These require access to sufficient capital. Finally, include: strengthening loan volume is critical to 3 strengthening the sustainability of microen- stration project proposed: terprise financing programs. Thus, FIELD challenged practitioners ACCION U.S. Network, through a Request for Applications process Cambridge, Massachusetts to build on their lessons about lending to Agency background: The ACCION low-income entrepreneurs and enhance their U.S. Network is comprised of six affiliated level of financing to the poor. Applicants nonprofit organizations, supported by the were asked to propose new financing prod- U.S. division of ACCION International, a ucts — such as equity products — or private, nonprofit organization dedicated to changes in their loan delivery process that reducing poverty by providing loans and could increase demand. In addition, to pro- other financial services to poor and low- mote better-designed products, applicants income people starting their own small were expected to conduct (or to have businesses. ACCION International is an already conducted) market research on their umbrella organization for a network of proposed innovations. institutions in 14 Latin American countries Further, applicants were required to and 10 U.S. cities. demonstrate a solid history of providing The affiliates participating in the loans to low-income entrepreneurs in their FIELD research project are located in past work, and a commitment to maintain- Chicago, San Diego, Albuquerque, El Paso, ing that focus in the activities undertaken San Antonio and New York. All are credit- with FIELD support. To receive a FIELD led programs, targeting Latino clients. To grant, applicants were expected to commit date, the ACCION Network has provided that at least 65 percent of the clients receiv- more than $17.8 million in loans to over ing the new financing product met FIELD’s 3,000 borrowers. Eighty-six percent of their definition of low-income (that is, at or clients are minorities, and slightly more below 150 percent of U.S. Health and than 30 percent meet FIELD’s low-income Human Services poverty guidelines). guidelines. Focus of grant: The ACCION The Grantees Network believes that by increasing out- n all, 35 organizations responded to reach and the overall efficiency of the lend- IFIELD’s Request for Applications with ing process, it can reach and serve more letters of intent. The five organizations borrowers. Thus, ACCION’s FIELD sup- awarded grants proposed to test a range of ported project will focus on re-engineering innovations that could help put capital two parts of the lending process: enhancing more readily in the hands of low-income marketing and sales, and streamlining the entrepreneurs. underwriting process. Efforts to enhance Key themes identified in the applica- marketing and sales will include implemen- tions process include: the need for innova- tation of a client-tracking system that tions in the field that affect loan quality, as ensures strong follow-up with clients well as demand; the need to simplify and expressing an interest in ACCION loans. standardize the loan underwriting process; To streamline its underwriting process, recognition that equity is an important ACCION plans to implement an informal financing option for low-income entrepre- credit scoring process, in which the affili- neurs; and recognition that there are dis- ates will collectively identify and focus on tinct niches among low-income entrepre- the personal and business factors that are neurs that require specialized products. identified to be most central to the under- The following pages offer a brief writing process. The Network will also description of each grantee and the demon- partner with Fair, Isaac to develop a formal 4 credit scoring model for microenterprise have some potential for growth, CEI will be loans. ACCION believes that character creating a “micro-equity” product. Drawing factors can be scored, and that credit scor- on its existing experience in community ing can be responsive to the characteristics development venture capital, CEI will of low-income borrowers. The successful examine three models: (1) traditional equity implementation of credit scoring will financing for incorporated microenterprises, enable the affiliates to increase the (2) a contract-based near-equity product for efficiency of their underwriting process, sole-proprietorship businesses, in which a focusing more of their credit officers time contract outlining the investment relation- on providing technical assistance to clients, ship will substitute for the ownership and marketing to new borrowers. Ultimately, arrangement in standard equity deals, and ACCION believes that the availability of (3) a royalty-based near-equity product. this model, which could be licensed for use For microbusinesses with smaller throughout the U.S., will not only enhance prospects for growth, CEI is planning to efficiency in the microenterprise industry, expand a current program in which it teams but also will attract traditional financial conditional grants with flexible term loans. institutions to this market. The grants provide a small amount of financing for business activities — such as Coastal Enterprises, Inc. (CEI), attendance at trade shows — for which the Wiscasset, Maine potential return is uncertain. They also pro- Agency background: CEI is a private, vide a means for highly risk-averse entrepre- nonprofit community development corpo- neurs to try out a new product or service ration engaged in a range of housing, without taking on additional debt. commercial and economic development activities. CEI began microlending in Community Ventures Corporation (CVC), 1980, lending to small farms and natural Lexington, Kentucky resource-based businesses. Since then, it has Agency background: CVC is a non- provided over $7 million in financing to profit community development corporation over 500 businesses, and provided technical that serves 25 counties in Kentucky’s assistance to 8,000 entrepreneurs. In 1998, Bluegrass Region. CVC began its microlending 48 percent of CEI’s microenterprise clients program in 1992, with its Bluegrass Micro- were women, 3.5 percent were minority, and enterprise Fund, a peer-lending program. 30 percent met HUD low-income guidelines. Since that time, CVC has also added a Focus of grant: CEI will offer two Small Business Administration (SBA) products aimed at increasing the level of its Microloan program through which it makes lending to low-income individuals: condi- larger individual microloans. Over time, tional grants teamed with flexible loans, CVC has made more than $1.1 million in and a “micro-equity” product. In its experi- loans to 231 entrepreneurs. Ninety-five per- ence in lending to low-income borrowers, cent of these loans have been made to indi- CEI has found that it needs to offer a range viduals meeting HUD low-income guide- of flexible capital products that match the lines (43 percent meet FIELD low-income financial requirements of individual busi- guidelines). In 1998, 64 percent of its 238 nesses and their owners. CEI already offers clients were women, and 71 percent were flexible term loans that can be structured to minorities. address cash flow requirements. However, it Focus of grant: CVC proposes to also has identified a need to offer equity create three new loan products that will financing as well. expand the organization’s continuum of For microenterprises that appear to loan products for low-income borrowers. 5 The new products are: state of New Hampshire by offering three • A “Jump Start” peer loan that will pro- different loan products. In designing its vide up to $500 to finance predevelop- products, NHCLF has sought to address ment costs of its training program grad- two challenges. The first is to create a range uates. This product will have reduced of products (including both peer and indi- underwriting requirements for clients vidual loans) and modes of outreach (offer- who have some access to sources of ing loans directly and in partnership with repayment beyond their businesses. local organizations) that can attract larger • An “SBA Express” loan that will provide numbers of entrepreneurs. The second is to small amounts of capital with rapid turn- carefully construct underwriting approaches around to SBA Microloan applicants who and criteria that can minimize the often very need small amounts of financing to meet a high costs of making microenterprise loans. short-term need (e.g., to fulfill a contract). The three products to be offered by Through this product, CVC hopes to NHCLF are as follows: serve clients who have found the current • A statewide peer lending program. underwriting process to be too lengthy. • The “Towns” project, which will offer • A consumer loan product for business lines of credit to municipalities and loan customers who experience personal other local development organizations financial needs that will impact the that have business counseling and/or business. The purpose of this product is underwriting capacity, but lack flexible to assist clients to meet personal needs capital to make microloans. that would otherwise draw cash out of • The “Specialty Trades” project, which their businesses. offers lines of credit to trade associa- tions, which in turn make microloans New Hampshire Community Loan Fund, to members. Concord, New Hampshire Agency background: The New West Central Wisconsin Community Action Hampshire Community Loan Fund is a Agency, Inc. (West CAP), non-regulated Community Development Glenwood City, Wisconsin Financial Institution (CDFI) that provides Agency background: West CAP is a loans to support affordable housing, as well community action agency that serves low- as self-help and economic development. income residents in seven rural counties in Although it made its first microloan in west central Wisconsin. The agency began 1987, the Fund became active in its microenterprise program in 1991 by microlending in 1992, when it became a providing technical assistance and training, local affiliate of the Working Capital pro- and added a loan fund in 1992. To date, gram. The Fund is now expanding its peer- the organization has made 89 loans, total- lending program statewide. (Working ing just over $315,000. West CAP served Capital is no longer active in the state.) 87 clients in 1998; 40 percent of these Over the past three years, it has made clients were women, and 69 percent met almost 90 loans totaling approximately FIELD low-income guidelines. $175,000. In 1998, 53.8 percent of its Focus of grant: West CAP’s project clients were women, 14.1 percent were aims to provide equity to businesses facing minorities, and 39.1 percent met HUD cash-flow issues in their early years. In ana- low-income guidelines. lyzing the performance of both its loan Focus of grant: The organization plans portfolio and the businesses it has financed, to expand the level of microlending in the West CAP has observed its clients strug- 6 GRANTEES AT A GLANCE Grantee Microlending Financing Financing History Hypotheses Product/Innovation

ACCION U.S. • Since 1991 • Credit scoring will increase the • Enhanced marketing and sales tech- Network; • More than efficiency of the underwriting niques for loan products. affiliates in: $17.8 million process, allowing credit officers • Creation of an informal credit score- •New York in loans to over more time for marketing and card by ACCION U.S. affiliates. • San Diego 3000 borrowers technical assistance. • Creation of a credit scoring model for • Chicago • Character factors can be scored. microenterprise loans. • Albuquerque • Credit scoring can be responsive • San Antonio to the characteristics of low- • El Paso income borrowers. • A successful credit-scoring model will attract traditional financial institutions to this market.

Coastal • Since 1980 • A continuum of financing • Blend conditional grants with flexible Enterprises, Inc., • More than $7 products is necessary to meet term loans. Wiscasset, ME million in loans the capital needs of low-income • Create a micro-equity product from to over 500 entrepreneurs among three proposed models: (1) tra- businesses • Equity products should be ditional equity financing, (2) a con- included in this continuum. tract-based near-equity product, and (3) a royalty-based near equity product.

Community • Since 1992 • Developing a longer continuum • “Jump Start” loan products that will Ventures • More than $1.1 of loan products will increase provide small amounts (up to $500) Corporation, million in loans scale and sustainability. to finance pre-development costs of Lexington, KY to 231 entrepre- • There is a need to address the training course graduates. Serves 25 neurs personal as well as the business • “SBA Express” loan, to provide access counties in financing needs of microentre- to small amounts of capital to SBA Kentucky’s preneurs. Microloan applicants who need capi- bluegrass region. tal to meet a short-term need (e.g., contract). • Consumer loan product for business loan customers who experience per- sonal financial needs that will impact the business.

New • Pilor program • Reaching large numbers of • Statewide offering of peer lending. Hampshire begun in 1992; entrepreneurs requires a range • Exploration of an increased loan size Community • Since 1996, has of products and modes of out- in peer lending, using new underwrit- Loan Fund, made almost 90 reach. ing approaches. Concord, NH loans totaling • It is important to build off of • Line of credit to towns that have the Operates approximately the pre-existing relationships of capacity to provide counseling and statewide in $175,000. entrepreneurs. underwriting. New Hampshire • Microlenders must carefully • Line of credit to specialty trade associ- construct underwriting ations. approaches and criteria that can reduce their costs.

West CAP, • Since 1992 • Equity is required to strengthen • “Business Investment Trust” accounts. Glenwood City, WI • 89 loans total just businesses in their early years of 40% of the monthly loan payment is Serves 7 rural over $315,000 operations. escrowed in the trust account. After 12 counties in west • Equity can be used to strength- consecutive months of on-time repay- central Wisconsin en repayment. ment, the client can access the funds to invest in inventory, equipment, working capital or leasehold/property improve- ments.

7 gling with business operations and loan • Documentation of results from the repayment at the 12- to 18-month period. financing products implemented by At this time, they have invested significant grantees. time and energy into their businesses, but • Production and dissemination of docu- continue to face an ongoing trade-off ments that capture lessons learned on between taking a salary or draw, and rein- issues relevant to the field. vesting in the business. Reports will be disseminated broadly to To address this need, they will create a policymakers, practitioners and other inter- Business Investment Trust, which will hold ested parties during and after the two-year in escrow 40 percent of each loan payment. grant period. After 12 consecutive months of on-time repayment, the client can access the funds About FIELD to invest in inventory, equipment or work- he Microenterprise Fund for Innovation, ing capital. Thus, the trust will provide TEffectiveness, Learning and both an incentive for loan repayment and Dissemination (FIELD) is a research and equity for the business. development fund dedicated to the expan- sion and sustainability of microenterprise The Learning Assessment development efforts, particularly those IELD’s mission not only is to seed inno- aimed at poor Americans. Designed to Fvation, but also to share the resulting make a significant, strategic investment in lessons learned with the microenterprise building the capacity of the microenterprise field. To ensure that the findings from these industry, FIELD makes targeted grants to grant activities will benefit other practition- practitioner organizations pioneering ers, the grantees and FIELD staff will work promising approaches to key challenges fac- together to implement a “learning assess- ing the field today. Its mission is to identify, ment” that will harvest and share the results develop, and disseminate best practices, and of these demonstration efforts. The process to broadly educate policy makers, funders will include: and others about microenterprise as an • Meetings at which grantees can antipoverty intervention. exchange information on implementa- OOR

P tion issues, preliminary findings and final results.

COMMON THEMES AND ISSUES ACCION Coastal Community NHCLF West CAP Enterprises Ventures Equity Products RODUCTS FOR THE X X P Pre-Startup Finance X X Continuum of Finance Products X X X Underwriting Criteria X X INANCING

F Product Marketing and Sales X Consumer Finance X USINESS B 8