SMALL BUSINESSES,BIG PAYOFFS
WHITE PAPER
Small businesses continue to be the gateway to growth opportunities
for bankers looking to expand their portfolios.

Navigating the New Lending Landscape.................................................................................. 3

CHAPTER 1: What Makes Small Business Lending Attractive?........................................ 4• Market Size
• Growth• Profitability• Untapped Opportunities
CHAPTER 2: What Makes Small Business Lending Unique?.............................................. 5• Value of Lender Partnerships• Less Financial Acumen• Commingled Business and Personal Finances• Risk Preparedness• Need for Efficiency
CHAPTER 3: What Are the Attributes of Successful Small Business Lenders?.......... 7• They Connect and Communicate with Business Owners• They Understand What is Unique About Each Business• They Ask Smart Questions• They Employ a Variety of Analysis Tools
CHAPTER 4: What Are the Best Practices for Small Business Lending Success?..... 9• Assess Lenders' Skills• Gain Management Buy-In• Focus on a Niche Market• Focus on Efficiency• Create the Right Culture
Lending to Small Businesses Presents Continued Growth Opportunities.................10

SMALL BUSINESSES, BIG PAYOFFS | 2

Navigating the New
Lending Landscape
How Lending to Small Businesses Is Moving
the Industry Forward Post-PandemicAs financial institutions look beyond
the consumer and commercial lending
channels for new opportunities, small
business lending—and its potential to increase
revenues—has captured their attention.
Small business lending straddles the continuum
between consumer and commercial lending.
But a small business loan is more than just alarge consumer loan or a small commercial loan.
Small business lending involves complexities
and considerations that are different from bothconsumer and commercial lending.
The small business lender, for example, must
become a trusted advisor to each particularbusiness. They must be able to identify theowner's needs, analyze both business andpersonal cash flow and debt, and assess credit
and repayment risks.
Developing these skills can have a significant
payoff. Financial institutions that take a targeted
approach to the small business lending market
have an opportunity to build the type of trusted
relationships that can result in increased revenues
and profitability.

SMALL BUSINESSES, BIG PAYOFFS | 3

CHAPTER 1: What Makes Small Business
Lending Attractive?
There are big growth and profit opportunities in lending small
Even though small business lending requires
specialized knowledge, there are serveral
reasons that it can be an attractive market for
financial institutions:Market Size
According to the U.S. Small Business
Administration (SBA), there are 33.2 million
small businesses in the U.S., comprising
99.9% of all firms.1

GrowthAs they recover from the pandemic, small
businesses continue to be a vital, growing
part of the U.S. economy.
According to the 2022 Small Business
Credit Survey: Report on Employer Firms, acollaboration of the 12 Federal Reserve banks,
the number of firms reporting revenue andemployment growth continued to build fromtheir 2020 lows. What's more, 78% of firms
surveyed expected revenue to either grow orremain stable over the next 12 months.2

Employer Firm PerformanceFirms reporting…

2021
Survey2022
SurveyRevenue growth

38%

44%

Employment growth

24%

29%

Source: 2022 and 2023 Reports on Employer
Firms

1
2
3

Profitability
For small businesses, obtaining the funding
they need is a top priority. Although small
business owners are price and interest ratesensitive, their desire to secure funding may
trump their need to shop around for the most
attractive rates. Because small businesses areoften willing to pay more for credit in order tosecure the capacity they need, the spreads onthese loans are often larger than the spreads
on mid-market or commercial loans.
In addition, while larger firms often rely ona chief financial officer or other executive tosecure credit and negotiate loan structure
and pricing, small businesses seldom haveaccess to such in-depth financial expertise,giving small business lenders the opportunity
to provide financial advice and deepen theirrelationships with the business owners.

To ensureprofitability insmall business
lending,
lenders needto understand
not only how
to position
small businessloans, but also
the financial
institution’s
credit products
and risk appetite.

Untapped Opportunities
For small businesses, getting the funding
needed for growth is problematic. Of thesmall businesses surveyed, 40% had applied
for traditional financing in the past 12 months,
a rate that exceeds pre-pandemic levels. Only
about half, however, were fully approved;
smaller firms (by revenue) were less likely tohave their needs fully met.3
Clearly there is a gap in the appetite ofsmall businesses for credit and the abilityof financial institutions to fund that need.
Although peer-to-peer financing companies,
such as Lending Club and Fundera, aregaining a foothold in the small business
lending market, most small businesses would
prefer to receive funding from traditional
lenders. Even with the rise of alternative
lenders, there is still significant untapped
potential for those financial institutions thatcan meet the needs of small businesses.

U.S. SBA Office of Advocacy, 2022 Small Business Profile2023 Small Business Credit Survey: Report on Employer Firms
2023 Small Business Credit Survey: Report on Employer Firms

SMALL BUSINESSES, BIG PAYOFFS | 4

CHAPTER 2: What Makes Small Business
Lending Unique?
Talking shop: Understanding the value proposition of small business owners
and their needs
Because small businesses have different needs
than retail or commercial borrowers, theypose different challenges for lenders. Even
though it’s common for small businesses—
and especially "mom-and-pop shops"—tosecure debt with personal assets, a lenderwith consumer loan expertise typically does
not have the knowledge needed to leadsmall businesses through the loan process.
And while commercial lenders may bewell versed in business terminology andunderstand complex financial principles andloan structuring, they often aren’t preparedto address the unique needs of the small
business market. Small business lending is lessabout loan structuring and more about credit
risk analysis for both business and personal
financial conditions.
The following are some key ways that small
business lending is different from consumer
or commercial lending.

Value of Lender Partnerships
Like most consumer borrowers, small
businesses appreciate quick underwriting
decisions. But they also want to work withlenders who understand their businessand its full financial picture, and who areable to offer recommendations to improvesmall business woes such as managing cash
flow, improving operational efficiency, andstructuring for growth.
In addition, small business owners are often
interested in how their firm compares to
its peers. Is it growing profitability at an
appropriate rate? Is it operating efficiently andin a way that can support growth? Lenders
who are comfortable in the small businessmarket can share insights into the strength of
the business and identify any red flags such as
too little liquidity, inadequate infrastructure, orhigh human resources costs.
In other words, small businesses valuelenders who can help them evaluate theirperformance based on benchmarking andindustry averages and offer suggestions for
improvement.

The financial institutions most successful insmall business lending employ lenders who
understand what small businesses value andwork to meet those requirements. These
lenders also serve as financial partners who
can make recommendations on improving thefinancing of the business needs.

Less Financial Acumen
Often small businesses do not have a chief
financial officer or someone on staff who
has sole responsibility for—and experienceand expertise in—finances. The vast majorityof firms will rely on their Certified Public
Accountant (CPA) for all things financial.
Sometimes the only financial documents thata small business generates are tax returns.
CPAs focus on tax minimization and reporting
business profits appropriately to the state andfederal governments. In fact, one of the top
financial concerns for many small businessowners is their tax burden.
However, the strategies used to minimize
taxes may be in conflict with the business’
credit needs. A small business with lower
reported income may pay less in taxes, butthat same income may impact the business’
ability to secure credit from a reputablefinancial institution when needed.

Commingled Business andPersonal Finances
Small businesses—especially sole proprietorships and other microbusinesses—tend toblur the lines between business funds andpersonal funds.
It’s not unusual for a small business owner tocommingle funds, perhaps using profits fromthe business to fund personal debt or viceversa. The small business owner may takeout a home equity line of credit (HELOC) tofund business expansion or to cover a delay inaccounts receivables, or use profits from thebusiness to fund a child’s college tuition.

In Practice
A carpet installation
business bid for—and
won—the contract for alarge corporation withmultiple locations.
Previously, the businesshad worked on muchsmaller installations andused the same pricing
scheme and similar
margins. However, thepricing for a larger
contract required different
parameters that thebusiness did not consider.
Since it had severely
underbid the contract,
the business wasn’t able
to hire supervisors tomonitor the installations.
Quality suffered and thecorporate customer withheld payment until the
problems were corrected.
The small business did
not correctly project
the liquidity it needed
to wait for the accounts
receivables to becollected. Unfortunately,
the business did notrecover.
A small business lender
could have helped it planfor that working capitalneed.

SMALL BUSINESSES, BIG PAYOFFS | 5

Of business owners whose firms had financial
challenges in 2022, 53% reported using
personal funds to alleviate them.4
A small business lender needs to evaluate
global debt service coverage and analyze
how the small business owner's personal
financial liquidity, debt, and cash flow impact
the business financial situation and ability to
repay the loan.

Risk Preparedness
There are many types of risks that cansignificantly impact a small business—or
potentially even put it out of business.
For example, a small business with fewer
resources and cash reserves is more
vulnerable than a large firm to business cycles
and economic events such as recessions.

Efficiency is Critical for Profitability
While the spread on small business loans
is attractive, the smaller dollar amounts
mean that financial institutions will need tofund more loans. Scalability—being able toefficiently underwrite and approve a larger
volume of loans—is critical to success in small
business lending.
Part of the puzzle depends on the financial
institution's ability to automate and streamline
small business lending to get these loans
approved, booked, and monitored efficiently.
Another part of the puzzle depends on thelender's ability to quickly assess the feasibilityof the loan, identify risk, and then work to
structure a loan to mitigate those risks.

The most
successful small
business lenders
are constantly
learning. Eachbusiness theywork with, every
lending need
they assess, andevery loan thatis approved or
declined adds totheir experiential
learning.

Operational risk is tricky for small businessowners to predict and control. Issues suchas the loss of a key employee or productdefects can quickly derail a small business’
profitability.
Small businesses are also vulnerable to natural
disasters—and they often aren’t prepared
for it. According to the National Oceanicand Atmospheric Administration, in 2021
there were 20 separate billion-dollar natural
disasters in the U.S. Twelve percent of small
businesses reported natural disaster-related
revenue losses that year.5 Though statistics
vary, all suggest that most small businesses
do not have disaster insurance. Additionally,
FEMA has estimated that as many as 25%
do not reopen after experiencing a disasterrelated closure.

452023 Small Business Credit Survey: Report on Employer Firms
The Impact of Natural Disasters on Small Businesses: Findings From the 2021 Small Business
Credit Survey

SMALL BUSINESSES, BIG PAYOFFS | 6

CHAPTER 3: What Are the Attributes ofSuccessful Small Business Lenders?
In addition to creating loans and managing credit, small business lenders learn
about owners' needs and challenges
The small business lending market isunderserved, with many small businesses
either unfunded or underfunded. Financial
institutions can address this need for credit
while leveraging small business lending todeepen relationships with customers andimprove profitability—if they have lenders
with the right skills. Here are five attributes ofsuccessful small business lenders:

They Connect and Communicate
with Business Owners
Small business lending success requires that
lenders connect on both a personal andprofessional level with business owners. These
lenders need excellent communication skills
and the ability to inspire confidence that they
can meet the small business owner’s needs.
Lenders should be comfortable networking
with business owners at such events aschamber of commerce mixers or professional
association gatherings. They should
be cognizant of a potential borrower’s
relationship with centers of influence, such as
attorneys and CPAs, and be able to leverage
those relationships into additional banking
opportunities.

They Understand What is Unique
About Each Business
Small businesses, like their owners, areunique. The most successful small business
lenders embrace those differences and seek
to understand how an individual business'
capital and operating cycles function andsuggest products and services that are mostappropriate based on these cycles.
It’s important that the lender appropriately
identifies the actual need and helps theowner identify potential future needs, before
recommending proposed solutions.

Even within similar businesses, differences
exist. An attorney in a solo practice will
likely have a different borrowing profile fromattorneys in a group practice. A fast-foodfranchise may have a different profile from afamily-run delicatessen.
The key point is that a small business lendershould be able to engage with a small businessowner in a manner that demonstrates that thelender truly understands the business owner’s
needs and can recommend the correct loan
product based on those needs.
These conversations—or “talking shop”—go along way toward building a relationship andgaining credibility with a small business owner.

They Ask Smart Questions
Once the lender demonstrates that they
understand the challenges the owner faces,
it’s time for the lender to drill down into thedetails of the business's immediate financing
need, as well as its bigger-picture financing
strategies.
There are a variety of questions small
business lenders need to ask to identify themost appropriate products and services.
What differentiates the business from its
competitors? How does cash flow into andout of the business? Are payments received
by cash or credit card? How much does thebusiness pay for merchant services?

In Practice
A pizza shop approached
its financial institution
for a line of credit. By
understanding the very
fast operating cycle ofa cash- and credit cardbased business, thesmall business lender
was able to explain thata line of credit was not
an appropriate productfor this particular small
business because it does
not need to financeaccounts receivables,
and inventory turns
over quickly.
Instead, the small business
lender was able to recommend more appropriate
products and services,such as a term loan forequipment to fund thepizza shop’s expansion
from two to threelocations next year.

A small business that has higher-thanaverage operating expenses or cash flow
management issues will not be as profitable
as it could be. Alternatively, a business that
does not collect its accounts receivable in atimely manner may create a cash crunch thatreverberates throughout the business andhinders its ability to expand or grow sales.

SMALL BUSINESSES, BIG PAYOFFS | 7

Or, perhaps the small business is paying
above-average merchant fees on credit anddebit card transactions. By bundling merchantservices within a full relationship with thefinancial institution, the lender may be able tooffer more attractive pricing.
A lender who can ask smart questions abouta variety of topics, such as management
expertise, organizational structure, growthplans, and the competitive landscape, canquickly get to the root cause of a fundingneed and add value to the relationship. These
lenders can also quickly weed out poor loan
candidates, rather than waste time going backand forth for additional documentation, only
to ultimately decline the loan.

They Employ a Variety ofAnalysis Tools
Small business owners often intermingle
business and personal funds. In order toanalyze the business' ability to repay the loan,a small business lender must evaluate boththe business financial statements and owner's
personal financial statements and calculate
global debt service coverage. Also, because
tax returns are often the only professionallyprepared financial statement a small businesshas available, the lender must be able toreconcile them with financial statements
created in an accounting program such as
QuickBooks.

Once a lender has a clear picture of the root
cause of the need for funding, they shouldbe able to analyze the facts. This requires a
combination of financial analysis techniques,
including ratio and cash flow analyses, andsensitivity analysis to predict whether the
borrower will have the capacity to repay
new debt.
The lender can then structure a credit
package that meets the borrower’s needs andstands an excellent chance of being repaid
as scheduled. The lender should ensure thatthe repayment schedule both matches thebusiness’ available cash flow and is withinbank policy and target profitability returns.
If the lender determines that the business’current capital structure is not optimal, theyshould be prepared to suggest alternative
solutions through organizations such as the
Small Business Administration (SBA) or otherstate and local economic assistance programs.
Finally, the lender should be able to advise thesmall business owner about ways to improvetheir financial position in order to qualify forsmall business loans in the future and leverage
additional bank services to enhance theiroverall operations.

A lender who
can ask smart
questions abouta variety of
topics, such as
management
expertise,organizational
structure, growthplans, and thecompetitive
landscape, canquickly get to theroot cause of afunding need andadd much value
to the overall
relationship.

SMALL BUSINESSES, BIG PAYOFFS | 8

CHAPTER 4: Best Practices for Small
Business Lending Success
How traditional financial institutions are powering their growth
Few lenders possess all the skills needed tosucceed in the small business lending arena.
There are a variety of ways to develop andenhance lenders' skills, including mentoring
and coaching or hosting informal “lunch
and learns” with senior credit officers.
Attending conferences or roundtables arealso appropriate and effective methods ofimproving skills.
For those new to small business lending,training can provide the foundation for skills
required. For experienced lenders, the best
training programs will allow lenders to testout of basic training and focus instead on
more advanced skills. Blended learning can behighly effective for achieving skills proficiency.
The following recommendations can help
foster success in small business lending:

Assess Skills
The first step in small business lending
success is to identify any deficiencies inthe banker's skill set, regardless of theirexperience.
After the institution has assessed lenderskills, it can then provide the training that iscustomized for each individual lender. Theseskills include tax return analysis, generalbusiness acumen, risk identification, and theability to assess the management skills of thesmall business’ leadership team.

Gain Management Buy-In
When they understand how small business
lending can increase profitability and deepen
customer relationships, leaders will be eager
to support training and experiences that
increase lender performance in those key
areas. This support should be communicateddownward throughout the institution.
One of the most effective methods ofsupporting skills improvement is to takea top-down approach and ask everyone
who manages lenders to become familiar

with the training; to act as mentors to theirlenders to support the training and transfer
of knowledge; and to kick off any training
by explaining how it will benefit both theorganization and the lender.
The most successful small business lenders
are constantly learning. Each businessthey work with, every lending need theyassess, and every loan that is approved or
declined adds to their experiential learning.
Management should encourage underwriters
to discuss with lenders the reason for a decline
or counteroffer to further experiential learning.

Focus on a Niche Market
Some financial institutions have developed
expertise in targeted industries such asprofessional services firms or medical
practices. Focusing on niche lending
markets has several advantages for financial
institutions. First, the institution can shorten
the length of the underwriting process,granting loan approvals more quickly byleveraging small business lenders who arewell versed in a specific industry.

Small business
lenders shouldbe able toengage with asmall businessborrowers ina manner that
demonstrates
that the lender
truly understands
the businessowner’s needs
and canrecommend thecorrect loan
product based on
those needs.

A small business lender with expertise of thiskind is better able to ask the right questions
upfront, reducing back and forth between thesmall business and the financial institution andimproving efficiency.
Second, asking the right questions—andunderstanding the business—also allows thelender to identify risk factors and mitigate
those risks before sending the loan tounderwriting. A small business lender withexpertise in medical practices understands
the accounts receivables collections risk
associated with Medicare and Medicaid versus
private insurance, for instance.
These lenders are also able to weed out
poor loan candidates much more quickly
and manage customer expectations more
appropriately upfront. Furthermore, they canoffer valuable guidance to the customer tosupport them in their future credit journey.

SMALL BUSINESSES, BIG PAYOFFS | 9

Focus on Efficiency
Financial institutions can improve efficiency
by implementing a well-defined approvalsystem based on the amount of the loan.
For smaller amounts, the institution cantruncate the approval process and approveor reject the loan based on credit scores
only, similar to an approval for an unsecured
business credit card. Although these loans
may not perform as well as those that
undergo more intensive underwriting, theefficiency gains offset the slightly higher
credit risk.
For higher amounts, the institution canemploy credit scoring plus require fewer
financial documents for underwriting, perhaps using only two years of financial statements. The underwriter can then prepare amore simplified cash flow or debt service
coverage ratio for analysis.
Even larger loans can be approved efficiently
if the financial institution offers well-definedloan products that do not require complex
and time-consuming loan structuring.

Create the Right Culture
To foster success, create a culture within thesmall business lending area that recognizes
success in making sound credit decisions,and supports and encourages learning andapplication of new skills on the job. Support

this culture by providing time and study
space in which to complete training; providing
access to senior lenders for discussions
about lending culture and policy; recognizing
successful completion of training; andcoaching for sustainment.
To ensure profitability in small business
lending, lenders also need to understand thefinancial institution’s credit products and risk
appetite.

Small businesses,
like their owners,
are unique. Thoselenders who aremost successful
in small business
lending embracethose differences.

The credit department can play a crucialrole in this regard, educating small business
lenders on the approval process; techniques
for evaluating cash flow, collateral, or otherforms of support; and offering suggestions
for strengthening the overall relationship. At
the same time that the lenders are learning
important skills, the credit team is being
afforded leadership opportunities.
Finally, task the credit department with
explaining the reasons for declines, so thelender better understands the institution’s
credit culture and risk appetite. In addition,
they should advise on what is needed to
get to a bankable opportunity. Forging
communication between the small business
lenders and the credit team enables
the lender to focus on deals that fit theinstitution’s profile. This partnership also
supports the banker's continued experiential
learning through collaboration.

Lending to Small Businesses Presents Continued Growth Opportunities
Small businesses throughout the U.S. are underserved by financial institutions, with many not receiving the credit they need. This
presents an opportunity for financial institutions to expand their small business lending programs. But small businesses have different
borrowing needs, and lenders with experience in consumer or commercial lending often lack the specific skills needed for small
business lending success.
The key is to approach small business lending holistically and as a means of deepening customer relationships. Because small
businesses are typically owned by a single individual or a small group of individuals, a small business lending relationship has thepotential to increase the borrowers’ overall relationship with the institution with deposits, personal loans, owner investments, and cash
management. While the small business loan itself may not be highly profitable, the bundling of other products and services can turn asmall business borrower into a profitable and attractive relationship.
The most successful small business lenders can connect and communicate with business owners, understand the unique requirementsof small businesses, ask the right questions, and then apply their knowledge and understanding to tailor customized solutions to theindividual business. Financial institutions that invest in their lenders and provide them with training in these skills will be the mostsuccessful in small business lending both today and into the future.

SMALL BUSINESSES, BIG PAYOFFS | 10

THE MOODY'S ANALYTICSDIFFERENCE
We understand that your business operates in a highly competitivemarketplace where the skill level of your associates correlates
directly with enterprise success. We leverage the expertise of
our own credit, banking, and training experts to ensure that our
training solutions provide your organization with targeted content
in multiple delivery formats that enable growth in the volume andquality of your loan portfolios.

Get in touch for more information
about our learning solutions.