Bulk Buys to Microloans

When Sam’s Club approached Valley Economic Development Center President Roberto Barragan looking for a way to help its small businesses clientele, he was ready with an ambitious proposal. Instead of taking the $2 million in offered grants and making direct loans, Barragan suggested that his Sherman Oaks non-profit would use its banking connections to leverage the money into $20 million in loans to itself. The center would in turn loan that larger amount to economic development non-profits around the country, which themselves would make microloans to entrepreneurs. Sam’s Club’s original money would be held as a type of collateral called “loan loss reserve” in case some of the microloans went bad. In return, Barragan promised some big results: 4,000 new jobs, 500 new businesses and loans to 2,500 existing businesses in low-to-moderate-income neighborhoods. The program, called the National Microfinance Fund, was officially announced last month in conjunction with Small Business Week, though it is not making loans just yet. Barragan said it took a long conversation with Sam’s Club, a unit of Wal-Mart Stores Inc. in Bentonville, Ark. to explain the advantages of his proposal. “They aren’t in financial services, but they saw the magic of leveraging,” he recalled. “They wanted to support that kind of growth.” The Microfinance Fund is part of a $13.6 million five-year initiative by Sam’s Club to grow small businesses through better access to capital, especially for women, minorities and veterans. It includes grants to raise awareness about predatory lending, develop better online access to Small Business Administration loans and conduct research on micro-enterprise development. “VEDC’s National Microfinance Fund is a key part of our philanthropic strategy to scale micro and small business loans to underserved business owners,” Gayatri Agnew, director of opportunity at the Walmart Foundation, said in a statement. But how effective it will be is another matter. The microlending model of economic development emerged in the late 1970s as a market-based solution to poverty. Muhammad Yunus, a Bangladeshi economist, won the Nobel Peace Prize for pioneering the practice. Eventually, non-profit development groups adopted the model in the United States. But some scholars believe microfinance suffers from too much hype while doing too little to alleviate poverty. A report last year from the non-profit NextBillion.net, a predevelopment antipoverty website, concluded that “microcredit programs generally create no net additional employment or income,” both in emerging economies and developed countries. Barragan is aware of the criticism, but said his experience at the VEDC doesn’t support that view. While VEDC’s bread and butter is SBA loans – it originates loans worth $35 million a year through the federal agency’s programs – it has been making what it considers microloans for 20 years. The term “microlending” typically connotes loans of a few hundred dollars in developing countries, but in the context of the U.S. economy, Barragan applies it to loans up to $100,000. He said the VEDC has made about $11 million in such loans, with the average amount of $14,000 and a net loss of less than 2 percent. As for job creation, Barragan said that VEDC’s microloans create one or two jobs for every $10,000. For the new Microfinance Fund program, the loans will be roughly $20,000 with terms up to five years. Promising sectors include construction contractors, small retailers and transportation and logistics services. The goal is to get the business up and running and establish enough credit history to qualify for a regular bank loan. “Microlending is not a good long-term financial solution,” Barragan said. “A bank is a long-term solution.” Of course, with the new fund, VEDC won’t make the loans directly, but will act as an intermediary lender. However, Barragan said his organization plans to share its successful model for microlending with the other non-profits, who will receive loans from VEDC from $500,000 to $5 million. “We are looking for organizations that have managed losses and delinquencies, that have adequate net assets, and a history of microbusiness growth and job creation,” he said. Before the program can begin, Barragan must first secure the VEDC’s $20 million in loans, and he said he is in talks with bankers now. Once the money is received, the VEDC will make its loans to it non-profit partners, who will have to repay them. Barragan figures the entrepreneurs will pay interest rates in the 7.5 to 9.5 percent range, about the same that VEDC charges on its portfolio of small non-collateralized loans. The non-profits that lend to the entrepreneurs will collect payments and then pay VEDC a rate of 3 to 4 percent. Barragan expects to secure loans from banks at interest rates in the 2 to 3 percent range. The fund will begin rolling out in California and expand to Nevada, Utah, Arizona, Idaho and Oregon – states where VEDC already has an established presence. Eventually, Barragan hopes to take it national. Given VEDC’s own experience with job creation, he expects the $20 million in microloans can create 4,000 jobs. “Once we deploy the capital, those numbers will be achieved,” he said. Barragan believes his model will work in other cities, and he has expanded the VEDC’s presence accordingly. In 2012 VEDC acquired a non-profit lender in Henderson, Nev. and last year it opened a loan operation in Florida funded by $5 million from Swiss investment bank UBS. Earlier this year it acquired a $5 million loan portfolio in Oakland from a defunct community development lender. Now the Sam’s Club fund will open another prong in the expansion strategy. “Beyond our offices in eight cities, through our relationships with banks and via intermediaries, we can provide loan products nationally,” Barragan said. “Frankly, we are a national financial intermediary, a national small business financial institution.” Strategic doubts But Arneel Karnani, associate professor of strategy at the University of Michigan Ross School of Business, and an expert on microfinance, doesn’t believe small loans are a viable poverty-reduction tool. He said if you ask poor people what they want, most will answer by saying “a job.” “These are entrepreneur out of necessity, not choice,” he said. “For every success story, there are plenty of people who get stuck. The business fails and they can’t even repay the loan. This is a romanticized view that the way to help poor people is to give them a microloan.” While Karnani’s research has focused on microfinance in developing countries, he said he’s “equally skeptical about it in rich countries.” The VEDC offered San Fernando Valley businesswoman Lidia Alvarado as a counter example. She received a microloan for $9,500 from VEDC to move her company, Alvarado Tax Service, to a better location in Panorama City. The new office on the street has given her walk-in business, and she employs one part-time administrative assistant and two licensed preparers during tax season. “If it wasn’t for (VEDC), I would have gone out of business,” she told the Business Journal in Spanish. “In truth, it wasn’t very much money I needed, but it was my salvation. And they gave me advice, legal help, and classes that were bi-lingual.” Karnani added that the only way microloan programs usually succeed is by giving more than money, but a lot of microfinance organizations lack the capability to provide management consulting, marketing, operational and legal advice or real-world connections to struggling entrepreneurs. Barragan maintains that in addition to VEDC and other non-profits’ expertise, he plans to tap Sam’s Club to help microloan recipients. “We are talking about how to coordinate once we have lenders identified to connect them to local Sam’s Club operations, including how they can distribute promotional materials in the store,” he said.