Debt Capital Primer: Banks Don’t Drive Economic Expansion, Private Investors Do

Next time you feel tempted to give up the search for debt capital to grow your business, consider these astonishing facts:

* According to the World Bank, total bank debt in the United States totals half of our gross domestic product. By way of contrast, total bank debt totals 170% of GDP in Germany, 150% in Japan and 100% in Malaysia.

* The U.S. bond market, on the other hand, equals 110% of GDP here. It equals 90% of GDP in Germany and 75% in Japan. It comes only to half of GDP in Korea and to less than 10% of GDP in Thailand and Indonesia.

These figures are compelling because they show where businesses do and do not borrow money.

How? “Total bank debt” comprises all the money banks lend to car buyers, credit card holders, consumers, homeowners and hosts of others, including business owners.

Take out the loans to car buyers, credit card holders, consumers and homeowners and it becomes apparent that banks don’t do much lending to business owners.

The bond market, on the other hand, generates great pots of debt capital for business. In fact it generates far more debt capital for business than do banks. The disparity remains huge even when you allow for the fact that the bond market also finances government debt.

And since the bond market consists largely of private investors lending capital to businesses on their own and through their pension plans, mutual funds, life insurers and other institutional buyers of bonds, we can draw a simple conclusion: Banks don’t drive the expansion of the American economy. To a very great extent, banks drive expansion, such as it is, in other countries, but not in the United States.

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In America, private investors drive the economy by funneling equity and debt capital into businesses--equity capital through the stock market, debt capital through the bond market.

These private investors assess risk and reward on their own, free of the legal and regulatory constraints that hem in your banker when you ask for a business loan. They do not, of course, drive the expansion of small businesses through the organized bond market. Instead, they work in a market that’s informal and inefficient and ultimately frustrating to business owners looking for debt capital.

Efficiently or not, private investors do lend to small and mid-size businesses. Indeed, the World Bank actually understates the importance of private debt investors in the U.S. economy when it calculates the bond market at 110% of GDP--because the bond market doesn’t tally the debt capital that investors make available to small and mid-size businesses through the financing techniques regularly described in this space, including mezzanine and asset-based lending deals.

No one knows how much money small and mid-size businesses raise through such techniques. Surely it’s a big number, but in any case the problem isn’t how much money business owners can raise here. The problem is how to get business owners and investors together so they can do their deals.

Many business owners try to woo their local banker, only to find they can’t meet the banker’s collateral requirements. On the lenders’ side, investment bankers gravitate toward deals involving big business in an efficient marketplace that generates big fees.

This makes searching for expansion capital a big job.

Interestingly enough, however, it still pays to start your search with your banker. These days bankers understand that they play a small role in financing American businesses, and they want to change that fact--insofar as they can, given their inability to take big risks with their depositors’ money. It is one thing to note that banks don’t count for much when it comes to supplying small to mid-size businesses with debt capital. It is another to say that they don’t want to.

In fact they want so much to get a piece of the action that, these days, they do deals of a sort they would not have dreamed of a few years ago, including some that encroach on the territory of asset-based lenders such as finance companies, which lend against the value of a business owner’s accounts receivable. These loans present banks with much bigger risks than they see with, say, auto loans or credit card debt. But bankers want to lend money just as much as private investors do; indeed, there is so much pressure on banks and private investors alike to put their capital to use that all the players in this arena find creative ways to do business.

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It remains to be seen, of course, how long banks will work these deals. For the moment, even if banks don’t count for much in the big picture, when you add up what they do for small to mid-size businesses with what other sources of debt capital do, you find a marketplace with a good supply of money looking for work.

In short, capital is available from a great many sources, including your friendly local banker. So while you search for capital to grow your business, the question isn’t whether suppliers of capital exist. The question is whether you can find them. The search takes work, but it pays.

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* Next: How the competition among banks to lend money increases the odds that you can find working capital for your own business.

Freelance writer Juan Hovey can be reached at (805) 492-7909 or by e-mail at jhovey@gte.net