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Financing Products 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
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