This memo is in response to a request from Councilman Chapman for information about microloan financing and strategies the City may consider to support small business and entrepreneurs. Staff from the Alexandria Economic Development Partnership (AEDP), Office of Housing, and Small Business Development Center (SBDC) collaborated to evaluate microloan financing practices within our region and that resulted in the development of two options aimed at increasing business owners’ access to capital. Under the first option the City would establish its own program to provide through AEDP microloans directly to businesses. The second option provides funding support to certified third-party organizations with lending experience similar to what has occurred in prior years. Staff’s research has concluded that creating a standalone City operated program would be onerous, time consuming and duplicative. The City and business community would be better served by making funding available to established lenders to make loans to qualified business owners and entrepreneurs.
The Small Business Administration’s (SBA) microloan program provides small businesses with small short-term loans. The SBA makes funds available to specifically designated intermediary lenders, which are nonprofit organizations with expertise in lending and technical assistance. These intermediaries then make loans to eligible borrowers in amounts up to a maximum of $50,000.
SBA microloans are designed to assist business startups or expansions, and are typically utilized by business owners with limited credit history and who need to borrow less than amounts banks usually lend. The loans must be used for working capital or eligible business expenses such as inventory, supplies, fixtures, machinery and/or equipment. Applications are submitted to the local intermediary and all credit decisions are made at the local level. Borrowers are required to provide collateral and personally guarantee the loan. The SBA’s average loan size is around $13,000 with a maximum repayment period of six years. The interest rates on microloans can vary but are normally in the range of 7.5% to 8.5% which is higher than rates offered by commercial banks.
The City has a history of helping small business owners gain access to capital. Through the Office of Housing, support targeted the Potomac West area including the Mount Vernon Commercial Revitalization Task Force and The Avenue Partnership initiatives in the late 1980’s, followed by the Potomac West Alliance in the 1990’s. The City used Community Development Block Grant (CDBG) funds to provide loans to businesses in the Potomac West Enterprise Zone to spur new business development and create jobs through its Commercial Revitalization Loan Program and Business Assistance Loan Program (BALP). The City also supported a façade improvement program along the Mount Vernon Avenue corridor. Two highly successful Del Ray businesses, Evening Star Café and the Daily Planet (which grew into the Neighborhood Restaurant Group collection of restaurants), were beneficiaries of the BALP program.
In 1999, the City provided support for the first time to the Microenterprise Loan Program, operated by the ECDC Enterprise Development Group a nonprofit microloan intermediary based in Arlington County. This $50,000 allocation of CDBG funds provided support for both operations as well as funding for the organization’s loan loss reserve account. ECDC’s loans, offered on a City-wide and regional basis, could provide financing up to $25,000 to entrepreneurs unable to qualify for traditional sources of credit. Support to ECDC has continued depending on the availability of CDBG funding. The most recent allocation of CDBG funds to ECDC’s Enterprise Development Group (EDG) was approved in FY 2014. One of Housing’s early CDBG investments in a local dance studio is featured in a video produced by the City last year (https://www.alexandriava.gov/Housing).
Finally, the Alexandria SBDC dedicates resources to helping small business owners access traditional forms of capital. The SBDC is familiar with a broad range of lending programs and sources of capital, including microloans, and provides one-to-one consultations to business owners to help them identify the needs of the business and loan program that is most likely to meet those needs. In its sixteen-year history, the Alexandria SBDC has helped to facilitate over $71 million in loans.
MICROLOAN INTERMEDIARIES AND BEST PRACTICES:
There are at least four SBA Microloan Intermediaries currently operating in the D.C. metro area. To learn more about lending practices provided by intermediary lenders, staff visited the nonprofit ECDC Enterprise Development Group based in Arlington which has previously received City funds as noted above. Staff learned that in CY 2016 the Group provided 27 loans to Alexandria businesses totaling $677,729. All borrowers were minorities and low-income individuals, and the majority of loans were used to purchase vehicles such as trucks or taxis used in the transport industry. Approximately 60% of the loans were used for business expansions with the remaining 40% used for startups.
The EDG is primarily funded from government sources: besides the City’s prior funding, other funders include the SBA and Arlington and Fairfax Counties, with other funding coming from private partners. Information provided to staff indicates that EDG is conducting its loan programs in accordance with SBA guidelines and overall best practices. The EDG site visit along with input from industry experts helped staff identify several elements of successful microloan programs, including source(s) of capital, a Loan Loss Reserve (LLR) fund, policies to guide lending practices, systems to minimize risk, procedures to address loan defaults, and staff to evaluate and monitor loans.
Another critical element to microloan financing is the borrower. Most microloan programs traditionally help borrowers who may not be able to get a loan from traditional sources, like a bank, gain access to capital. In many cases borrowers are low-income individuals or from underserved populations such as minority or refugee communities. If City Council were to consider supporting a microloan initiative, Council would need to provide direction on the type of business owner or target population Council envisions benefiting from the initiative.
Staff has developed two initial options based on input from industry experts and research. The first option would create a City-administered microloan program. The second option would allocate City funds to existing intermediary lenders similar to past City practices. Staff supports Option #2.
Option #1 – City-Administered Microloan Program
A City administered program would provide direct loans to small businesses and entrepreneurs. The City would be responsible for screening applicants, making loans, managing repayments, and overseeing loan defaults. In addition to allocating money for loans the City would also need to create a Loan Loss Reserve to protect against uncollected loans. An LLR of 15% of the total loan program would align with best practices. Creating a new microloan program would be a multi-year project that would likely require the city to hire outside expertise to build the program. The program would require strict policies and procedures to minimize risk which could potentially result in eligibility requirements that could restrict certain populations from qualifying for a loan. AEDP should oversee such a program. While the Housing Office has extensive experience managing its mortgage portfolio, the City does not have expertise to underwrite and manage a business loan program and existing rules currently prohibit the SBDC from directly managing lending programs.
Option #2 – Support Existing Intermediary Lenders
Supporting local existing SBA approved intermediary lenders would provide loans to small businesses and entrepreneurs through a third party. This scenario greatly reduces the City’s risk and substantially leverages City investment by capitalizing on the expertise, staffing resources and relationships within existing organizations to manage and monitor lending. This option also allows the City to deploy resources faster than Option #1 which would require significant lead time to create a program structure and train and/or hire staff.
Calculating the fiscal impact of a microloan initiative is challenging because it is difficult to anticipate the number of existing or future business owners who may request financial support. If City Council supports Option #2, it could start a program with as little as a $50,000 per year investment. Using the SBA’s average loan size of $13,000 as a baseline, a $50,000 annual investment would finance approximately 3 to 4 microloans. This strategy could serve as a beginning measure to provide financial assistance to small businesses while staff looks for additional funding sources and longer-term investment strategies. The City through AEDP or SDBC would also conduct annual monitoring of EDG loan activity.
Emily Baker, Deputy City Manager
Helen McIlvaine, Director, Office of Housing
Shane Cochran, Division Chief, Office of Housing
Stephanie Landrum, President & CEO, Alexandria Economic Development Partnership
Ryan Touhill, Chief of Staff, Alexandria Economic Development Partnership
Bill Reagan, Executive Director, Alexandria Small Business Development Center