This article originally appeared in the September 2023 issue of THE SHOP magazine.
By Mark E. Battersby
The recent wave of bank failures has put a new focus on the security and stability of financial institutions. Even with protections in place, a bank’s failure can be disruptive, causing delays and confusion regarding access to funds, not to mention the potential impact on funding necessary to every business in the automotive aftermarket industry.
Most small businesses face little risk of a failed bank. The Federal Deposit Insurance Corporation (FDIC) insures deposits of up to $250,000, an amount far less than the $12,100 balance for most small businesses revealed in a recent JPMorgan Chase Institute survey.
The potential risk increases for automotive aftermarket shops with many employees, however, or for those funded by venture capital. In any case, it’s important to full confidence in your banking partners.
AVOIDING POSSIBLE BANK FAILURES
Now that the panic from the collapse of not only SVB (Silicon Valley Bank) but also Signature Bank appears to be diminishing, experts are suggesting that small businesses examine their accounts to determine their level of risk and protect their deposits from potential future bank failures.
Fortunately, thanks to government programs, most small shops face little risk of their banks failing.
Even so, diversifying accounts is usually a good idea. As mentioned, the FDIC insures each depositor at each institution—not separate accounts at one institution. Having a second banking relationship makes it easier to quickly wire funds to safety when worries develop about one institution being unstable.
Since these protections usually come into play only after the fact (such as after the failure of a bank), it is critical that shop owners and managers take the necessary precautions to avoid needing these protections. The safest course of action is to do your own due diligence and distribute your risk.
A typical Due Diligence Checklist might include:
- Assess the overall health of the operation’s bank
- Review the bank’s investments
- Ensure the bank participates in so-called “stress tests”
- Regularly monitor the bank for material changes
- Protect deposits beyond FDIC depositor protection such as with accounts in more than one institution
MITIGATING RISK
Surprisingly, it is banks themselves that may offer the most protection from possible failure.
The IntraFi Network is a system that can split a customer’s large deposits into smaller chunks that are below the $250,000 cap and send those chunks to other banks in the system. The result? Customers have multiple FDIC-insured accounts without having to open each one independently.
One option involves the bank chopping a customer’s money into certificates of deposits (CDs) of less than $250,000 before placing those accounts in other institutions. While the CDs earn interest, the money can’t be withdrawn before the CDs mature.
A second option involves a so-called “sweep account,” where a customer’s balance in excess of $250,000 is “swept out” to other banks periodically in smaller blocks. With both options, deposits are protected by the FDIC because, technically, they are sitting elsewhere.
Although free, banks usually limit the service to businesses with uninsured deposits. Even if eligible, however, an automotive aftermarket professional may not want to utilize either option, leading to copying bigger operations by creating a treasury strategy.
TREASURY-RELATED PROFITS
Aftermarket professionals know how difficult managing an operation’s finances can be. Tracking profits and losses, planning future expenditures and securing expansion capital can be challenging.
One answer is treasury management—those back-office, behind-the-scenes services that enable small businesses to make and receive payments electronically, in-house or through a financial services provider.
While accounting software can usually handle day-to-day cash flow management, treasury management is more involved. Both in-house and via outside providers, treasury management includes handling the operation’s holdings with the ultimate goals of managing its liquidity and minimizing potential risk.
A simple switch to electronic deposits wherever possible can improve cash management, keep deposits safer and save time. Plus, there is faster notification of attempts to deposit checks where there might be a lack of funds.
For some shops, in-house treasury management might also incorporate the Automated Clearing House (ACH) clearing network for electronic payments. ACH is an efficient, economical way of making and receiving payments.
ACH payments are made by directly transferring funds from one bank to another, cutting out the use of paper checks. While it costs an average of $1.22 to process a paper check, the same payment can be processed for pennies using ACH.
TODAY’S FUNDING OPTIONS
In a recent National Small Business Association (NSBA) poll on the current state of lending following the collapse of SVB, more than half of the respondents said they were unable to obtain adequate funding even prior to the collapse, with a third claiming terms had become less favorable.
It’s not that banks are reluctant to lend to small businesses but, rather, traditional financial institutions have outdated, labor-intensive lending processes and regulations that are often unfavorable to smaller organizations. When credit dries up and liabilities become harder to roll over, there may be a need for alternative financing.
Alternative financing refers to any method through which performance, restyling and customization professionals can acquire needed capital without the assistance of traditional banks.
Generally, if a funding option is based entirely online, it is considered an alternative financing method. By this definition, options such as crowdfunding, online loan providers and cryptocurrency qualify as alternative financing.
Among the reasons why a shop might turn to alternative financing are:
- Lower credit requirements. Traditional banks are almost certain to decline loans to borrowers with poor credit
- Faster approval. Traditional bank loans can take weeks to be approved, whereas some business loan alternatives provide access to funding in as little as one week.
- Easier qualification. Not all small business owners meet the additional requirements to apply and be approved for traditional loans. In these cases, business loan alternatives are helpful.
ONLINE OR BRICKS AND MORTAR?
Small-business lending is becoming a big business, with hundreds of millions of dollars raised from unique platforms such as crowdfunding, peer-to-peer lending and marketplace lending. The entire lending marketplace is an emerging segment of the financial services industry that increasingly uses online platforms to lend directly or indirectly to consumers and small businesses.
As the needs of investors and financial services customers become more complex, there is a demand for effective tools to simplify the process. So called “digital transactions” involve constantly evolving methods where financial technology (fintech) companies collaborate with various sectors of the economy to take advantage of new lending and capital raising opportunities.
Financial institutions are increasing the digitized services they offer while the financial marketplace competes with offerings such as peer-to-peer lending, alternative online financing and crowdfunding.
So, how can an automotive aftermarket business take advantage of these speedy financing options while avoiding the risks associated with borrowing from so-called “shadow banks?” One option is marketplace lending.
Online marketplace lending refers to the segment of the financial services industry that uses investment capital and data-driven online platforms to lend directly to small businesses and consumers. While the newer “marketplace” funding remains largely undefined, it encompasses lenders that make loans to higher-risk, lower-income borrowers, as well as micro-finance and larger-scale lenders that market their products to traditional consumers and small businesses.
The U.S Department of the Treasury has issued a rather broad definition for “marketplace lending,” stating it is “the segment of the financial services industry that uses investment capital and data-driven online platforms to lend either directly or indirectly to small businesses and consumers.”
It goes on to say: “Companies operating in this industry tend to fall into three general categories—balance sheet lenders, online platforms (formerly known as peer-to-peer or P2P), and bank-affiliated online lenders.”
While the volume is tiny in comparison with traditional bank lending, marketplace lending has experienced rapid growth, with new lenders originating over $12 billion in loans. Marketplace lenders employ new, largely automated underwriting processes.
In fact, some online lenders purportedly rely on “big data” not evaluated as part of traditional bank underwriting processes. Unfortunately, there has yet to be one consistent, concise definition of what marketplace lending truly means or universal guidelines for qualifying.
TIME TO PREPARE
While bank accounts remain safe because regulators have shown a willingness to step in when needed, experts advise small businesses to diversify their funds while cementing their relationships with their bankers. Preparing for the potential of a bank failure is something that should be started today.
Mark E. Battersby writes on financial and tax-related topics.
