Many credit unions have considered lending to small businesses. Many already have! Lending to a self-employed member is a form of small business lending, even if we don’t consider it as such. Members come in a variety of forms. Those who are employed, receiving other forms of income, or who are self-employed. Here, we are speaking of those who are self-employed.

Members may run their own business in a variety of ways. As a sole proprietorship, in the form of a partnership, or in the form of a corporation. In whatever form they choose, the need here is not only to evaluate how well the member performs their “job,” but also how well they run the business that provides their job! Clearly, if they are unable to run the business successfully, there may not be a job for them down the road!

Expansion of services

In this day and age, where credit unions are being required to be mindful of things such as growing their loan portfolio, mitigating against interest rate risk, concentration risk, etc., small business lending might be the answer, as long as it’s done mindfully and performed by staff that has been well-trained in small business lending.

While NCUA identifies a “Member Business Loan” at $50,000 or more individually or in aggregate to a business, prudency dictates that even smaller loans to small businesses be entertained, processed, underwritten, and closed by a credit union staff member who has been trained and is experienced in small business lending.

Where to start

Perhaps the best way to start is to partner with a CUSO that can process loans while you gain experience in small business lending. Once you gain experience, you might want to start by making fixed asset loans, e.g., for the purchase of vehicles and other fixed assets like machinery and equipment. I would caution against starting off by financing commercial real estate or by providing working capital financing. There is additional expertise that is required for both of these types of financing.

I would also recommend that a credit union considering starting a small business lending program start off small, limiting the amount of loan capital it will invest, and by clearly articulating its “Program Expectations,” e.g., anticipated volume, staff requirement, yield, losses, etc. Only then can a credit union monitor their performance against its expectations.

Business loan underwriting

As to “underwriting” a business applicant, repayment ability is typically measured by a business’s debt-service-coverage ratio (DSCR) which is their cash flow (net income + depreciation + amortization) to debt service obligations (monthly loan payments). It’s basically the inverse of the debt-to-income ratio A debt service coverage ratio of 1.25x or greater is sought.

As to evaluating repayment willingness, in most cases it’s based on the credit history of the “principals” of the business, those that own 20% of more of the business. In the case of a sole proprietorship, that would be the owner, in the case of a partnership, that would be the partners, in the case of a corporation that would be the folks that own 20% or more of the stock of the company.

Lending is lending

At the end of the day, lending is lending, whether a credit union lends to an employed individual or a self-employed individual, you still need to consider the basic aspects (the C’s) of credit — membership standing, repayment ability, repayment willingness, and a secondary source of repayment (collateral). In the case of self-employed borrowers, you also need to consider management’s ability to successfully run the business so that there is repayment ability going forward.

You will also want to consider conditions that might adversely affect the business, as well as the extent to which the owner has invested in the business. Business lenders feel more comfortable when the business owner has invested in their own business.

Small business lending can be done successfully and profitably, and can be a great addition to your product offering if done mindfully and prudently! Best wishes!