For those of you who are not familiar, a CDFI is a Community Development Financing Institution. In the small business world, these organizations make small business loans to companies and entrepreneurs who would be unable to get a traditional bank loan due to a lack of collateral, poor credit, no business history, a small loan size, or a host of other factors.
I don’t have an exact count but, based on my work in this space, I estimate that there are about two dozen CDFIs of various sizes in Chicago, give or take a handful. I think that’s more than enough and I hope we stop funding new CDFIs in our city and use that money elsewhere. Here’s why:
There are basically three main groups of entrepreneurs who use CDFIs:
- Entrepreneurs who don’t have the necessary capital but are trying to launch a new company
- Established business owners who need the money but can’t qualify for a bank loan because of poor credit, lack of collateral, and/or the loan just being too small to be worth the bank’s time
- Established business owners who know they’ll want to qualify for a traditional loan in the future and want to rebuild their credit in preparation for that
Let’s take a look at each of these situations one by one.
First is the entrepreneur trying to launch a new business. Yes, much of the performance gap between white, male owned businesses and female and/or minority owned businesses can be attributed to startup capital because it’s much less likely that entrepreneurs from these groups can access the checkbook of the literal or figurative rich uncle. However, startups are incredibly risky. If a new entrepreneur is someone who makes so little money in his/her current job and/or has such a low credit score that s/he can’t use some combination of savings and credit cards to get up and running enough to demonstrate some traction, a small business loan to launch a business is likely a really bad idea. Most businesses fail and this person will not have a way to pay back this loan if their business does (or even to make the payments when it takes longer than expected to become profitable, as it nearly always does), so they’ll only have further damaged their credit and financial situation.
Yes, there are some specific situations where a very small startup loan could be useful. For example, maybe someone is starting out with a lawn-mowing business and pre-sold contracts for the summer but doesn’t begin to collect payment until she begins to perform the work. Signed contracts in hand don’t give her the money to buy that extra lawnmower she needs and a bank isn’t going to bother with a loan for the $500-$1000, but a CDFI could help her out immensely. I don’t disagree in this situation, there are just already more than enough CDFIs around to make this happen for everyone in this situation in Chicago.
Alternatively, if an entrepreneur is looking to build a high-growth startup, as opposed to a lifestyle business, but lacks the ability to raise the typical family and friends round of funding, what we need is a source of equity capital, not another CDFI that provides debt, which is inappropriate for this type of startup at this stage.
Second is the established business owner who needs an infusion of cash but has spotty cash flow, poor credit, no collateral, or the loan is just too small for a bank to be interested. Now, a startup is one thing, but once someone’s been in business for a few years, issues like these are simply symptoms of the actual problem of poor management and throwing a loan at it isn’t going to solve that underlying problem. Instead of creating yet another CDFI to put a Bandaid on the problem’s symptom, perhaps we should invest that money in improved coaching and training options to help get the business and entrepreneur to a point where s/he can qualify for a bank loan or be able to self-fund projects that are too small to be worthwhile for a bank.
That would require a fundamental revamp of the way we fund and operate non-profit entrepreneurship support, however.
Finally, we have established business owners who know they’ll be looking to qualify for a business loan in the future and want to repair their credit now. This makes total sense and this group of entrepreneurs is well-served by existing CDFIs.
When we actually dig into the issue of a lack of access to capital and the reasons for that lack of access, it’s clear to me that we don’t need another CDFI in Chicago. What we need is a better method for directing the right business owners to the appropriate CDFI resource that is already available to help, equity financing options for under-served entrepreneurs building promising high-growth startups, other forms of financing – like revenue participation – for those businesses that shouldn’t take on debt or equity investment, and more effective, more comprehensive training programs to build the capacity of other business owners.