Micro Loans, Macro Results
Microfinance supports Utah entrepreneurs, and is key to economic recovery
by Brad Plothow
Nearly a quarter-century ago, the prospect of education and entrepreneurial prosperity lured Jorge Fierro to the U.S. from his native Mexico. Upon emigrating to Salt Lake City, Fierro began searching for a place to buy quality Mexican fare, but nothing he found in local grocery stores measured up. Fierro turned the conundrum into opportunity.
Recognizing a potential business niche, Fierro began hawking fresh pinto beans at a downtown farmer’s market. After developing a solid customer base, he decided it was time to expand. That would require capital, though — money for supplies, packaging and to rent commercial space. Problem was, Fierro’s credit history and lack of collateral precluded him from obtaining a conventional loan. Enter microfinance.
In October 1997, Fierro and a business partner secured a $10,000 loan from the Utah Microenterprise Loan Fund, a non-profit community development financial institution established to help would-be entrepreneurs like Fierro. Rico Mexican Market, which began as pinto beans on a card table, is one of roughly 200,000 microenterprises (very small business) in Utah, representing a quarter-million jobs, or nearly 18 percent of all employment in the state. Especially in times when credit is tight, like today, many of these businesses would never get off the ground if not for microloans.
“The loan made it possible for me to start and build the business,” Fierro says. “Our business means stability, security, freedom and assures an education for our family. But it also means that and more to the many families employed by us.”
Today, Fierro’s company employs 45 people and distributes 125 products to 60 grocers from Wyoming to Nevada. Fierro’s story illustrates the significance of this kind of lending — which is quite different from venture funding or traditional bank financing — both for budding business owners and the people they employ. And in times when a conventional loan is more difficult to obtain, microfinance may play an even bigger role in lifting the economy out of the mire.
What is microfinance? By definition, microfinance means making very small loans to people who need business capital but can’t qualify through banks. These loans are typically less than $35,000 and might be used to purchase, say, a lawn mower for someone starting a landscaping business. Nationwide, there are roughly 25 million microenterprises — businesses with five or fewer employees that need only a small initial capital outlay.
“Without the microloan alternative, many of the 25 million microenterprises operating today would not be around and they would not be creating jobs.”
– Connie Evans, president and CEO, Association for Enterprise Opportunity
As an organized practice, microfinance really began in the 1970s when non-profit organizations began making microloans in developing countries. The trend proliferated as it became apparent that many of the recipients parlayed the capital into viable businesses. As of 2006, there were about 3,000 microfinance institutions serving some 100 million disadvantaged people around the world, according to the Microfinance Summit Campaign Report.
Microfinance is not a long-term funding option for entrepreneurs — Ricci describes UMLF as “lenders of last resort” — and it is not an alternative to private equity or angel money. Private investors and banks serve people in very different circumstances compared to microfinance customers, so the roles of each funding source are quite distinct. In fact, microlenders will often refer people to banks if they think they are better suited for traditional financing. Microfinance is also different from venture capital in that microlenders can’t make large notes — which excludes capital-intensive startups — and they don’t seek an equity stake.
Impact during the downturn As the slow economy continues to drag on job creation and crimp small business lending, the scope and definition of microfinance is evolving. The current economic conditions create a landscape that makes microlending all the more relevant. Millions are out of work, so people need to find income. Credit is tight, so people need an alternative source of small business funding. And the subprime mess left many with significantly damaged credit, so people are looking for a second chance. (Microlenders don’t report to credit bureaus, but they’re also more likely to overlook past credit problems.) “Without the microloan alternative, many of the 25 million microenterprises operating today would not be around and they would not be creating jobs,” says Connie Evans, president and CEO of the Association for Enterprise Opportunity (AEO). “The credit crunch has made business capital even more inaccessible for microentrepreneurs and demand for microloans has increased significantly over the last two years.”
“For many residents of our community, self-employment and microenterprise development offers a significant opportunity to provide income and a sense of hopefulness.”
– Kathy Ricci, Executive Director, Utah Microenterprise Loan Fund
In Utah, the UMLF lent to 42 and 43 business in 2005 and 2006, respectively, but that number shot up to 52 in 2007. For Utah, which has a diverse economy dependent on small business, this trend is likely to persist, especially as the economy continues to drag. Nationally, microlending is gaining notoriety, especially as the government looks for tools to put people back to work. The AEO estimates that microenterprises create about 850,000 new jobs a year, and AEO credits microfinance with creating 1 million new jobs when unemployment crested during the 2002 recession. That low-hanging fruit is obviously attractive to politicians and policy-makers.
“Even in times of economic downturn when other industries are shedding jobs, America’s smallest businesses continue to create jobs in communities nationwide,” Evans says.
The downturn has also affected the definition of microfinance. Microloans were once limited to $25,000 or less and targeted primarily in developing countries, but today more than half of all AEO members make loans up to $150,000. In addition, President Barack Obama recently recommended increasing the Small Business Administration’s microloan limit from $35,000 to $50,000.
Microfinance in Utah
The AEO reports that its members have made roughly $300 million in loans to budding entrepreneurs. In Utah, the UMLF began in 1991 — making it one of the older microloan institutions in the country, according to Ricci — and has lent about $7.4 million, with an average loan of $13,000. The direct impact, of course, is that entrepreneurs like Fierro have access to opportunity, and the ripple effects are that tens of millions of dollars find their way into the local economy. For Fierro, obtaining a microloan wasn’t an economic imperative — he had a job and was not living in poverty. But it was key for his entrepreneurial endeavor. In addition to providing the capital needed to start his business, Fierro’s microloan set him on the path to establishing a stronger credit history. In fact, he received financing through a bank after paying back his UMLF loan at about 8 percent interest within two years. For every Jorge Fierro, however, there is someone who is wholly dependent on a microloan to make something of nothing. According to Ricci, 15 percent of female UMLF recipients are single mothers, and 13 percent of all UMLF clients are immigrants. Microloans help these people replace income from a lost job, develop talents and skills and build up assets that can be used to create wealth. “The whole idea is to get capital into the hands of people who are enterprising, talented and skilled, but who can’t get what they need through traditional means,” Ricci says.
Compassion or compliance? The role of a 1977 law in microfinance Some lenders may be motivated by altruism to make microloans, but others take their cues from the 1977 Community Reinvestment Act, which dictates that banks and other financial institutions must lend to low- and moderate-income groups. Assessments relative to CRA compliance become especially important when applications for mergers and acquisitions are reviewed. Issuing microloans is one way to satisfy the CRA requirements.
“We are a vehicle for banks and other lenders to do commercial lending to these underserved groups,” says Kathy Ricci, executive director of the Utah Microenterprise Loan Fund.