Tuesday, January 1, 2013

‘Debt Peonage’ for Small Business Owners

A recent article in the Huntsville Times by Paul Huggins discussed ‘lending’ practices for small businesses during the depression. The banks weren’t interested in making loans to small businesses, so small businesses (farmers) had to depend on trade creditors (equipment & feed and seed dealers) to get them through cash crunches. UAHuntsville associate professor Dr. Stephen Waring referred to the loans a “debt peonage.” This is where everything the farmer owned was pledged to the lending merchant as collateral for the trade account. Debt Peonage is the practice of holding persons in servitude or partial slavery to work off a debt, in this case. Secret store prices lead to the small business being cheated by hidden fees and high finance rates.

Sound familiar? It should, we’re going through a similar time today. Most banks will not grant loans to small and start-up businesses. For them to even consider making such a loan, they require the business owner to pledge all his personal assets as collateral for the loan.
The article example was a very extreme case where the farmer ‘financed’ $5.57 in feed and seed product and had to pledge his entire farm as collateral. That’s pretty extreme.

The debt pricing practices today are more reasonable than in the 1930s; consumers are protected by laws that prevent lenders from gouging them with hidden fees and exorbitant rates. However, the things that haven’t changed are the use of trade credit to finance small business working capital and the pledging of all assets, even for a small loan. Most banks require the business owner to pledge all their personal assets to secure a small business loan. This practice can cause a small business owner real financial hardship, especially if they need to purchase a new vehicle, home, finance a college education for a kid or have a medical emergency. I’m not suggesting that we have a debt peonage situation today, just a lack of good financing options for small and start-up businesses. I’ve written and spoken about this for several years.

Entrepreneurs need to think about their financial situation very carefully before getting in a position where they have to make the best of only bad choices in financing their business. Cash flow issues are probably the single biggest ‘cause’ of small business failure. I use quotes around cause because the real cause is operator error. You, as the owner should have taken steps to prevent the condition or should have planned for this in advance. As my friend and mentor, Michael Gerber told me, these are the things small business owners should know before they start a business. Amen, Michael.

Do you have a story of a bad financial situation that you survived or need help getting out of a bad situation? Let me hear from you.

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