Citibank Tries a New Approach to Small-Business Lending ...

The Agenda

How small-business issues are shaping politics and policy.

The big United States banks have come under withering criticism for not lending enough to small businesses, but this week brings word that Citigroup, the parent of Citibank, will participate in a novel program to steer capital to small businesses that have an especially hard time getting it: those located in economically distressed areas. What?s novel about the program is that while Citigroup will provide most of the capital, it will not disburse it. Instead, it will rely on Next Street, a self-described ?merchant bank,? to underwrite loans to businesses that Next Street deems capable of rapid growth. If the initiative succeeds, it could serve as a model for similar programs around the country.

Next Street, with offices in Boston and New York, helps arrange financing for small-business clients, often from third-party sources, while at the same time providing the sort of tactical and strategic advice normally beyond the reach of those companies ? particularly businesses based in what are politely described in community development circles as low- and moderate-income neighborhoods. The newly formed Next Street Opportunity Fund will loan $30 million to established businesses in such communities.

To qualify for a loan, companies will have to have between $3 million and $60 million in annual revenue and a history of at least five or seven years. Individual loans will range from about $1.5 to $2 million and carry terms of five to seven years, at interest rates ?comparable to a traditional loan with commensurate risk,? said Tim Ferguson, a Next Street co-founder and partner.

At the same time, borrowers will be expected to retain Next Street as a consultant, if they haven?t already. ?Small businesses need access to high-level strategic advice, and we would argue that the strategic advisory piece is as important as the capital,? said Ronald L. Walker, Mr. Ferguson?s partner. ?The advice mitigates the risk.? The monthly fee for that advice ranges from $5,000 to $25,000.

That?s one distinction between an Opportunity Fund loan and a conventional loan. Another is the purpose of the financing. Mr. Ferguson said that when banks offer traditional forms of capital, like lines of credit and term loans, it is ?based on past performance, not growth. They?re not offered growth capital, from capital markets.? Next Street, by contrast, will pursue ambitious targets for Opportunity Fund borrowers. ?We do expect these companies to double in size,? Mr. Walker said. ?We?re talking about sustained growth over three to five years. And that?s top-line as well as bottom-line growth.?

Under the terms of the deal, Next Street is essentially borrowing the money for the fund from its investors, led by Citigroup, which is providing $25 million, and will then re-loan the money to its clients. Enterprise Community Partners, a nonprofit organization that supports affordable housing in 30 cities across the country, will contribute $2.5 million. The remainder will come from wealthy investors.

The Citigroup official overseeing the bank?s investment, Andy Ditton, conceded that the fund?s prospective borrowers were a difficult market for the institution to reach on its own, in part because traditional banking is not conducive for financing strong growth. But more than that, ?I don?t think the kind of businesses they?ll be lending to are the kinds of businesses any bank will lend to,? he said. ?The businesses they?re lending to are struggling, and they?re struggling because of their business strategy.

?The only way you can grow that business is to do the consulting, working with management for contract expansion and new relationships,? said Mr. Ditton, who helps manage Citigroup?s program for investing in disadvantaged neighborhoods, which is required under the Community Reinvestment Act. ?And that?s not the role a traditional banker would play. A bank lends money ? it?s not a series of management consultants, let alone Web page designers and that sort of people. It?s better for us to use people who have that expertise already rather than us trying to develop it.?

Half of the businesses working with Next Street are owned by women or minorities ? the population that finds it hardest to get any kind of credit at all, said John Taylor, president and chief executive of the National Community Reinvestment Coalition, which advocates for banking services in disadvantaged communities.

Mr. Taylor said that the aspect of the collaboration that is most appealing about the Opportunity Fund is that ?they?re providing growth capital without taking an equity position. There are VCs out there who?ll give you money, but they?ll take your fist born. You?re giving out the wealth of your business.?

But, Mr. Taylor added, the value of Next Street?s efforts would hinge on whether the fee structure is fair and whether the technical assistance provided is truly useful. ?If both of these things are true, it?s wonderful,? he said, ?because there is really a dearth of access to small business credit in general, particularly equity-type credit, and particularly for people of color and women.?

Next Street?s founding partners said neither concern was warranted. ?Our fees are always commensurate not only with the work that we do, but the opportunity in the business,? said Mr. Ferguson. And notwithstanding the minimum revenue and age requirements for borrowing businesses, in practice, he said, ?most will be $10 to $20 million in revenue, will have been in business for 10 to 15 years. And they have the capacity to absorb the fees.?

To questions about the quality of Next Street?s advice, Mr. Ferguson said, ?we wouldn?t have worked with over 100 small businesses if we weren?t adding value to these enterprises.?

The Next Street partners, and their backers, described the Opportunity Fund as a pilot project with rapid growth potential of its own. ?The perception is that the risk in the inner city markets for these type of small businesses is much greater than in the broader business lending marketplace,? Mr. Ferguson said. ?But what we?ve found from the limited amount of data that we can see, and from our own experience, is that the default rate is much lower than for the broader corporate marketplace. This pilot, if successful, will have people recognize that there is an opportunity to lend to these types of businesses, provided they couple it with the sort of advisory services that we?re talking about.?

Mr. Walker added that there are more than 25,000 similarly situated businesses in the country?s largest inner cities that could potentially take advantage of this type of financing. ?Next Street?s model has always been that there?s a need for this model nationally,? he said. ?This is a national opportunity.?

Citigroup?s Mr. Ditton agreed. And he said that if the project succeeds, other organizations would likely begin pairing strategic consulting with financing, and that the bank would be open to supporting those efforts as well. ?Our hope is that this $25 million is going to go out the door very quickly and show that there?s real interest in this, and that the companies they?re targeting will accept the help and the advice that Next Street is providing them and use the capital to grow and expand,? he said. ?If that all plays out, we hope to expand this to hundreds of millions of dollars nationally.?

Source: http://boss.blogs.nytimes.com/2012/02/02/citibank-tries-a-new-approach-to-small-business-lending/

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