Previously, I blogged about Ami Kassar’s views on the state of small-business lending. Kassar, the founder of Multifunding, feels that we need to find a way to “break through the gridlock in order to open up access to reasonably priced capital for small-business owners and entrepreneurs.” He is a big advocate for alternative lending approaches.
In a newer post from last week, Multifunding’s founder goes so far as to recommend the creation of new financial products with entrepreneur and small business needs front of mind. Here’s his concept: change the rules so that “loans” would have a component that allows lender to be repaid through the entrepreneur’s future earnings. Then, he takes it a step further to recommend that the earnings pay back continue regardless of where the entrepreneur goes in terms of employment, running a company, or starting another one. In his own blog, Kassar elaborates that the payments would need to continue until the obligation to the lender was satisfied in full. Quotes from the NY Times blog post last week appear below:
While I am sure that many will consider this idea controversial, it’s also fairly simple. If you are an entrepreneur looking for a loan, and you have enough confidence in your business or idea, you should be willing to pledge to pay a percentage of your future earnings — regardless of whether your current idea succeeds — until you have fulfilled your obligation. This way, the lender is betting not just on a particular company or idea but on a person, one who is willing to put his or her neck on the line.
Perhaps this financing could be offered by Federal Deposit Insurance Corporation-regulated banks that could leverage their low cost of capital to help small businesses. Of course, this would require federal bank regulators to think outside of the box, but a form of this type of financing exists. It’s called revenue-based financing, and it involves a lender’s making a loan to a company in exchange for a future piece of the company’s revenue. In this case, the financing is tied to the success of a specific company, and not to the future of the entrepreneur. And it comes with expensive rates.
The market clearly needs new forms of collateral in order to keep rates reasonable and in check. In today’s environment, many small-business owners are forced to use their homes as collateral — but with so many homes underwater, many entrepreneurs do not even have that option. The upshot is that this “collateral crisis” either stymies innovation or forces the entrepreneur to obtain capital from an alternative source at very high interest rates.
In the new model I am proposing, because the lender is assured of a piece of the entrepreneur’s future earnings regardless of whether the current business succeeds, the lender should be willing to be more flexible with terms and rates. And finally, the mechanisms to enforce these loans do exist. If we can track down deadbeat fathers for a piece of their future earnings, we should be able to do so with entrepreneurs.
Like the blog author, I wonder if entrepreneurs would be interested in such a loan. To offer up future earnings as a form of collateral seems drastic–unless you really believe that you have some great ideas in you. The upside, as Kassar presents his case, is an interest rate that is lower, though the term would likely be longer. Lenders, on the other hand, seem to be better protected against entrepreneurs who jump ship, but may have to wait longer for repayment. What are your thoughts about the approach?