No credit score cutoff, no collateral needed
Nonprofit lender making big changes to expand small-business loans on South and West sides
A nonprofit community lender is taking a new approach to small-business lending in Chicago: It will no longer consider credit scores or collateral in deciding whether an applicant should get a loan.
The decision to drop two standard lending metrics is part of an overall strategy change at Allies for Community Business, formerly known as Accion Chicago, which lends $500 to $100,000 to small businesses that struggle to get traditional bank financing.
Now, it is strengthening the free coaching services offered to entrepreneurs while expanding access to funds after watching small businesses struggle to navigate fast-moving regulations and financial assistance programs during the pandemic.
The change means giving up some of the standard tools lenders use to limit risk, but should help level the playing field for entrepreneurs in underserved neighborhoods, especially on Chicago’s South and West sides, said Brad McConnell, the organization’s CEO.
“The way traditional lending works just doesn’t work, really, for the communities we care about here,” he said. “If you rely on the same old metrics and you ask for the same super complicated documents the same way, you’re going to keep getting the same results. The well-organized, relatively well-off will do fine because they have plenty of help, and the rest won’t.”
An August report from the Federal Reserve Bank of New York found Blackowned businesses are less likely to have obtained financing from a bank than white-owned businesses even though recent surveys suggest they are just as likely to apply.
Even among businesses with healthy or stable finances, one-third of Blackowned businesses with employees obtained bank funding within the past five years, compared with 54% of white-owned firms, according to the report.
Finding ways to get capital in the hands of entrepreneurs in underserved communities will be especially important during the recovery from a health crisis that exacerbated economic inequality, said Seth Green, founding director of the Baumhart Center for Social Enterprise & Responsibility at Loyola University Chicago.
“Without strategies like this, we could lose a generation of entrepreneurs because the requirements of traditional finance are too difficult to meet, especially coming right out of the pandemic,” he said.
The East Garfield Parkbased lender also will help businesses develop timelines to reach certain goals and help them stay on track, McConnell said. The advising services are free and are not limited to borrowers.
Credit scores can be affected by financial challenges unrelated to someone’s potential as a business owner, like debt from a medical emergency. And when banks ask borrowers to put up the value of assets like their home as collateral, that penalizes business owners in areas with lower property values.
“You’re automatically saying to West and South side potential borrowers ‘You can get less,’ and that’s wrong,” McConnell said.
Allies for Community Business still will pull a potential borrower’s credit report but will consider different factors to decide whether to approve a loan. Borrowers must have made payments on other kinds of debt, such as a mortgage, credit card or business loan on time for the past year and can’t have sought bankruptcy protection within the last two years or maxed out other forms of existing credit.
All borrowers are asked to personally guarantee the loan.
The size of the loans Allies for Community Business makes — between $500 and $100,000 — will not change, nor will the standard two-year term. Interest rates will stay at 9%, with a 1% closing fee.
That’s higher than traditional bank loans and businesses should check out their options, said Ted Rossman, an industry analyst at CreditCards.com. But it’s lower than some alternatives, especially others aimed at businesses without collateral or good credit, since lenders usually offer lower interest rates when they know a business is healthy, he said.
Other lenders are trying to expand access to credit. Last fall, Huntington Bancshares Incorporated announced a $25 million small-business lending program that will make U.S. Small Business Administration-guaranteed loans of $1,000 to $150,000 to minority-, women- and veteran-owned businesses with lower credit score requirements, free financial education courses and longer-term repayment options.
Many community development financial institutions serve business owners that borrow amounts too small for traditional banks or who would have a tough time qualifying, though the lenders typically still consider traditional criteria like credit scores, Green said.
How much Allies for Community Business will lend this year depends in part on the pandemic. The organization disbursed more than $35 million in loans and $360 million in grants in 2020 because it helped distribute public and private emergency COVID-19 aid. The year before, it managed a portfolio of $4.7 million, with J.P. Morgan Chase and Chicago Community Trust as its largest sources of funding.
Accion never had a minimum credit score requirement, but credit scores were used to determine the maximum loan size, and loans of more than $25,000 required at least some collateral. The lack of a collateral requirement isn’t unique for small loans: The U.S. Small Business Administration does not require lenders take collateral on 7(a) loans under $25,000.
It’s not clear how many business owners found those requirements limiting, in part because Accion often recommended reducing the size of a loan rather than turning an application down outright, McConnell said. If an entrepreneur turned down the smaller amount because it wasn’t enough to fund their project, that wouldn’t show up in lending data.
Allies for Community Business plans to track loan performance over time and compare those made under the new standards to prior loans.
“There’s this terrible underlying assumption that has underpinned lending in minority communities that they’re more risky, and I think it’s false,” McConnell said.
Many small businesses are going to need not just emergency aid but mediumor long-term funding to rebuild after the pandemic, and those that have seen revenues decline or suffered hits to their credit score could have an even tougher time accessing capital, said Lotika Pai, managing director of access to capital at the Women’s Business Development Center.
If someone gets turned down for a traditional bank loan, turns to credit cards or other higher-interest options and misses a payment, that brings their credit score even lower, she said.
“It’s a vicious circle it’s really hard to break out of, and I believe it’s reflected in the history of communities of color,” Pai said.
Allies for Community Business’ program is “definitely a step in the right direction,” she said.
Even small-business owners who thought they would have no problem qualifying for a bank loan say they have struggled.
When Regine T. Rousseau tried to get a bank loan for her first business, a salon, in the late 2000s, repeated rejections felt “dehumanizing,” even though a nonprofit organization ultimately helped Rousseau and her business partner land one.
“We had everything we were told we needed. We had good credit, assets, sixfigure incomes,” she said.
She sold the salon, which has since closed, to her business partner, and began working full time on Shall We Wine, her Bronzeville-based wine and spirits marketing and events company.
In 2018, she needed financing to invest in a scheduling system to keep track of the hundreds of contractors that worked for her and help with cash flow, but was wary of trying to apply for a loan again.
Rousseau got a $20,000 loan from the then-named Accion.
While the financing helped, so did the coaching and mentoring, she said.
“I don’t think I understood the value until later, especially during COVID,” she said. “When you see how quickly something unexpected can wipe out many businesses, you really understand the value of an organization like Allies. If not them, who’s going to fight for the little guy or woman?”
“The way traditional lending works just doesn’t work, really, for the communities we care about here.”
— Brad McConnell, Allies for Community Business