It’s tough to bootstrap a craft or artisanal manufacturing business. That’s because it’s rare that profit – in the short term – is sufficient to fund expenditures for the accounts receivable, inventory, equipment, and marketing required for growth. Sooner or later, you’re likely to need some kind of external financing. The problem is that small-scale makers of consumer products don’t fit the criteria required by the usual suspects. If you need a few thousand dollars to maintain your business momentum, you may want to consider a Kiva Zip microloan as an alternative.
I spoke with Warren Vaughan and Heather Kearney about their experiences as a Kiva Zip lender and borrower, respectively. Their insights will help inform your decision about the conditions under which it might make sense for you to consider this innovative and inexpensive growth capital. First, though, let’s explore the structural reasons that gave rise to Kiva Zip.
A Misfit with Traditional Sources of Funding
Small makers of consumer products aren’t a good fit for traditional sources of business capital:
- Credit cards are readily available but expensive. The annual percentage rate (APR) on credit card balances can range from 15% to 30% or more. Furthermore, you may find that credit can be withdrawn if you maintain a balance for an extended period of time.
- Bank loans are for established companies that need to borrow tens of thousands to millions of dollars.
- Venture capital is for hyper-growth companies that offer the potential for a relatively quick “exit” by investors.
- Raising equity capital or loans from friends and family can place an inordinate strain on personal relationships if not structured carefully.
- Emerging peer-to-peer loan markets such as Lending Club can be a good alternative to credit cards, because they offer fixed rates and extended repayment terms. However, unless you already have an excellent credit rating, the rates on such loans can be very high.
What Bankers Want
Bankers are risk-averse – for good reason. A while ago, I spoke about why the behavior of bankers is easy to understand and anticipate.
The Pressure for Banks to be Big
Finance wants to be big. It’s easy to understand why. After all, which is likely to be easier and more profitable as a lender: making 1 x $1,000,000 loan or 1,000 x $1,000 loans? The economies of scale of finance is reflected in the growth in the average size of commercial banks over time:
- In 1994, there were 10,453 commercial banks that had, on average, $384 million in total assets.
- By 2014, the number of banks had fallen to 5,643, but their average size had grown to $2.5 billion in assets. The largest banks in the U.S. now have total assets of $2 trillion or more.
One consequence of these trends is that it’s increasingly difficult for banks to know their customers personally, even as technology has enabled lenders to access growing amounts of data about potential borrowers.
Character Has Gone Missing from the Credit Equation
Historically, lenders have relied upon the “4 C’s” to assess the creditworthiness of a prospective borrower:
- Character is a qualitative assessment of a borrower’s trustworthiness and will to repay a loan in a timely fashion.
- Capacity refers to the anticipated cash flow of the borrower relative to scheduled debt service payments.
- Capital is a measure of the strength and liquidity of the borrower’s balance sheet.
- Condition means the environmental conditions that could impact the borrower’s ability to repay its debt over time.
As banks have grown in size and, consequently, become more socially distant from their customers, they’ve come to rely upon readily observable data encapsulated in a credit score. That is, banks increasingly focus on the quantifiable aspects of capacity, capital, and condition. They’re less able to consider qualitative aspects of character in their lending decisions.
Those borrowers having a lengthy business track record, a requirement for large amounts of capital, a substantial balance sheet, and, consequently, a high credit score have benefited from expanded access to capital at competitively low rates and attractive repayment terms. Those businesses that have yet to achieve such benchmarks may have even experienced a decline in access to capital.
Kiva Zip is a Mashup of New Technology and Old School Character Lending
Kiva Zip is a non-profit that facilitates the crowdsourcing of 0% APR term loans from $500 to $10,000 through an online market that matches borrowers with individual lenders. Kiva Zip strives to reduce lenders’ reliance upon a borrower’s capacity and capital by emphasizing character. It does so structurally:
- Prospective borrowers must be sponsored by a Kiva Zip Trustee. The Trustee acts as a source of personal endorsement regarding the borrower’s character, business acumen, and potential for positive social impact.
- Before prospective borrowers can list their loan application on the public Kiva Zip website, they must demonstrate their capacity to raise a threshold amount from their friends and family network. Individual loan pledge amounts can be as low as $25.
- Finally, the borrower must receive pledges for the balance of their proposed loan amount within a specified period of time.
If these conditions aren’t met, the applicant doesn’t receive their loan. Advances and repayments are administered via PayPal.
Obviously, Kiva Zip lenders aren’t in it to make a killing. However, they do want to get repaid so they can relend the money to another worthy business. Rather than relying on credit scores and financial projections, Kiva Zip lenders mitigate their absolute risk through social underwriting and small dollar loans.
A Borrower’s Perspective
Heather Kearney is the owner of Montana Planks Wood Studio, an artisanal manufacturer of heirloom quality cutting boards constructed with upcycled wood. After building her sales via her Etsy store and area craft markets, Heather concluded that it was time to upgrade her branding and product photography, and that required the financial capacity to hire professional graphic designers and photographers.
In short order, Heather concluded that her business and loan request were just too small to be of any interest to local banks. Furthermore, she was wary of raising money on crowdfunding platforms such as Kickstarter through pre-sales for fear of distraction. Although she has a strong friends and family network, Heather wanted to ensure that any money she accepted from personal connections was of an appropriate amount and structure to allow for a good balance between personal and business relationships.
As Heather explains, Kiva Zip fit like a glove. The limit on the total loan amount forced her to prioritize her marketing expenditures. Furthermore, it offered her the prospect of building a credit track record for Montana Planks as a step toward accessing a larger amount of financing from traditional lending sources in the future. With the help of her network of friends, family, and customers, Heather was able to get pledges for her $5,000 loan request in a matter of a couple of weeks.
A Lender and Trustee’s Perspective
Warren Vaughan is a Kiva Zip trustee and lender. It was through Warren that Heather learned of the Kiva Zip microloan program. He’s been involved with Kiva Zip for about 18 months, during which time he’s endorsed five different businesses.
I spoke with Warren about why he’s involved and his perspectives on what makes Kiva Zip different. He also addressed the characteristics and tactics that allow business founders to raise money successfully. Warren emphasizes how important it is for borrowers to effectively build upon their existing friends, family, and customer relationships. He said, “This isn’t just some ‘hang your shingle out on the internet, and strangers will give you money,'” platform.
In a real way, Kiva Zip’s network of trustees emulates the role that used to be played by the community bankers of yesterday. That is, trustees have the ability to develop enough of a personal relationship with prospective borrowers to make an informed judgment regarding their character and business savvy. Although friends, family members, customers and others who already have their own relationship with the borrower may not rely upon a trustee’s endorsement, other lenders in the broader Kiva Zip community are likely to take into consideration the profile and track record of a borrower’s trustee when considering a loan. That, in turn, opens up the prospect of raising larger amounts via the platform.