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. It can cause delays and confusion regarding access to funds, particularly the potential impact on the funding so necessary to every commercial tree care business.
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 greater than the $12,100 balance held by most small businesses, as revealed in a recent JPMorgan Chase Institute survey. The potential risk increases for tree care businesses with employees (i.e., not sole-owner operators) or those being funded by venture capital.
The payroll exception
Payroll costs are among the biggest expenses for most in the industry. One survey of more than 300,000 small businesses stated that businesses with 50 to 99 employees, nearly half of all businesses surveyed, had monthly payrolls above $250,000. However, for the record, only 20% of all small businesses have employees, which, according to the Small Business Administration (SBA), means that few have significant payroll costs that can push their deposits above $250,000.
Avoiding possible bank failures
Now that the panic from the collapse of not only Silicon Valley Bank (SVB) but also Signature Bank appears lessened, the experts are suggesting that small businesses should examine their accounts to determine their level of risk and to protect deposits from potential future bank failures.
Diversifying banks 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 bank being unstable.
Since these protections usually come into play only after the fact, i.e., after the failure of a bank, it is much more critical that the tree care professionals 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 tree care 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, e.g., with accounts in more than one institution.
Mitigating the risk
Surprisingly, it is banks themselves that may offer the most protection from failure. The IntraFi Network, a system that can split a customer’s large deposits into small chunks that are below the $250,000 cap, sends those chunks to other banks in the system. The result? Customers have multiple FDIC-insured accounts without having to open each account.
The first option involves the bank chopping a customer’s money into certificates of deposit (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 arborist or tree care professional may not want to utilize either option, which could lead to copying bigger operations by creating a treasury strategy.
Profits from treasury-related actions
All tree care business owners know how difficult managing the 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.
Although accounting software can usually handle day-to-day cash-flow management, treasury management often involves more. Treasury management, both in-house and via outside providers, includes managing the operation’s holdings with the ultimate goals of managing its liquidity and minimizing potential risk.
A simple switch to electronic deposits whenever possible could improve cash management, keep deposits safer and save time. Plus, there is faster notification of attempts to deposit checks when there might be a lack of funds in an account.
An easy in-house solution
For some tree care businesses, in-house treasury management might incorporate the Automated Clearing House (ACH), the widely recognized clearing network for electronic payments. ACH is an efficient and 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.
Funding in today’s topsy-turvy financial arena
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 SVB collapse, with a third claiming terms have become less favorable.
It’s not that banks are reluctant to lend to small businesses. Rather, traditional financial institutions have outdated, labor-intensive lending processes and regulations that are often unfavorable to smaller businesses and 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 tree care 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.
The reasons a tree care business might turn to alternative financing include:
- 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 vs. brick 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, collaborating with various sectors of the economy, 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. How can a tree care professional take advantage of these speedy financing options while avoiding the risks associated with borrowing from so-called “shadow banks?”
Marketplace lending
The newer “marketplace” funding encompasses lenders that make loans to higher-risk, lower-income borrowers; microfinance services; and larger-scale lenders that market their products to traditional consumers and small businesses.
The U.S. Treasury has issued a rather broad definition for “Marketplace Lending,” stating that 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.” They go on to say, “Companies operating in this industry tend to fall into three general categories: 1) Balance sheet lenders, 2) Online platforms (formerly known as ‘Peer to Peer’ or ‘P2P’), and 3) Bank-affiliated online lenders.”
While the volume is tiny in comparison to traditional bank lending, marketplace lending has experienced rapid growth, with new lenders originating more than $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.
The path to coping with potential bank failures
Although bank accounts remain safe in the short term because regulators have shown a willingness to step in when needed, the experts advise it’s probably a good idea for small businesses to diversify their funds while cementing their relationships with their banker or bankers.
Coping with the potential of a bank failure is something that should be done today. In addition to helping you be prepared, the strategies that reduce the risk of exposure to a bank’s failure can be quite profitable for every tree care business.
Mark E. Battersby is a freelance writer based in Ardmore, Pennsylvania. He has contributed tax and financial articles to TCI Magazine for more than 20 years.
