by Joseph Kenny | 03/22/09

The times have spoken: for small firms, getting credit from banks is something that just isn't going to happen for the time being, nor for the foreseeable future.

That said, small firms aren't just going to shrivel up and go quietly, at least not all of them. Those that are to stick around are looking for new ways to secure credit so that they can continue to carry on their operations during the current recession and beyond.

While it's been difficult for some time now for small firms to borrow new capital from banks, the tension is spreading and affecting even current borrowers in perfectly good standing. For instance, many small firms that rely on overdraft protection from a month to month basis, such as restaurant owners and small shop owners are finding that banks are pulling the plugs on their overdraft protection without warning, sighting the relationship as being simply "too risky" to leave intact in the current economic climate. The result is that these small firms are either going elsewhere for money or dying out.

What's more is that it's not just the refusal of banks to lend credit that is going to affect the landscape of the small business owner. The refusal of these banks is creating a sense of real animosity between creditors and borrowers such that, even after the crisis is past, it seems unlikely that things will ever go back to the way they were, and banks really need to be concerned that these small firms are just going to adapt to the new sources of funding they find, making them the new de-facto way of doing business in a way that may just make part of the function of banks totally obsolete.

So just where are these small firms going to get their cash? Public equity is a decreasingly attractive option, analysts are saying, as the market continues to plunge. Instead, private equity seems to be the way to go for most small business owners who have already established themselves and have a proven customer base or compelling business plan that is likely to attract interest.

Those without substantial credentials to back up their claims have been increasingly looking to an option known as the SEDA. With a SEDA, a private investment fund agrees to loan needed funds to a firm for up to two years in return for a stake in the company and its profit. In essence, it's very much like public equity, but without the need to compete in a failing stock market. However, the groups offering these types of funds are relatively scarce (for obvious reasons), and accordingly, this trend alone isn't going to fill the gap being felt by small firms throughout the country.

While the relationship between small firms and big banking may never be the same again, it's hard to say exactly which relationship is going to replace it. As funding becomes harder and harder to secure, privately funded enterprises may be the only option for small firms for the foreseeable future. What lesson can one learn from this debacle? If you're looking to start a small business of your own, or even just looking for funding to pay your way out of debt, there's a real need to analyze the lendor's risk tolerance and make sure that you aren't likely to exceed it. If it seems risky, the relationship probably isn't meant to be.