The small business bootstrap paradox

It is difficult to obtain financing as a small business. The primary reason is a limited track record or time in business. Without having demonstrated a pattern of success, banks are hesitant to lend and often have requirements that you be in business for two or three years.

During this time, small business owners must self-fund their business, or “bootstrap.” Owners must use any resources they have: Cash, home equity, and credit cards to purchase inventory or equipment to grow the business. Banks encourage this behavior and risk-taking. It is viewed as a disciplined and respectable way to grow a business.

Upon reaching two or three years in business, however, these bootstrapping behaviors now serve as a risk to obtaining a loan. High credit card utilization lowers your personal credit score. Using personal savings or home equity diminishes the equity on a personal financial statement. As a result of absorbing all the risk, business owners are worse off and less likely to obtain bank credit.

For this reason, we have seen a rise in Community Development Financial Institutions. “CDFIs” are often funded by private organizations (including banks) to provide loan support to marginalized communities. These organizations have more flexible underwriting guidelines because they understand the gap in financial services and how small financial contributions can have an outsized economic impact. A list of CDFIs in your community can be found here.

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