These Resilient Financial Structures Can Make Our Economy Stronger
Authors: Sean Campbell
The way most businesses are financed plays a major role in making our economy less resilient. Most businesses need to raise capital at some point — to expand, to buy inventory, or to smooth out inconsistent cash flows — and typically they do so by borrowing money. But, the structure of most loans is inflexible. If you don’t pay your monthly loan payment, you’re in default and your lender can take whatever collateral you’ve pledged — definitely your business assets and possibly even your home and other personal assets.
Most of the time, the cost to the lender of actually taking these assets is prohibitive (especially for smaller loans), which makes it especially irrational for lenders to attempt to foreclose in the middle of a global pandemic when it will be impossible for them to sell any collateral that they take.
But in the current return-maximization framework, business owners have to prioritize paying their lenders over everything else (like paying employees or suppliers) or face foreclosure. This applies throughout the economy — landlords may want to forgive rent, but they have mortgage payments to make. Intuitively, this system doesn’t make sense.
Do lenders really expect that they’re going to come through this crisis with no losses even as the economy comes to a halt? Likely not, but, in the absence of an alternative, they are continuing to function within the framework that’s been established.
One of the reasons that business financing is so rigid is that lenders believe that these rigid structures insulate them from losses. Traditional lenders will typically only make a loan if they think that the value of the collateral exceeds the amount of the loan by so much that they think that it’s impossible for them to lose money. However, as we’ve now seen many times (in the COVID crisis and ten years ago during the housing crisis), this security is an illusion. Lending money is inherently risky, no matter how you structure it since factors can always change — and ironically, structures that are designed to look risk-free (like conventional business lending) actually create more risk by reducing resiliency. The features of conventional loans that look like protections put more pressure on borrowers and increase the chances that an unexpected event causes a crisis to spiral out of control.
What might an alternative capital system that is built for resiliency look like? One promising approach is loans with flexible repayment features, where a borrower’s monthly payment varies depending on how their business is doing. Another promising approach is community and character-based lending, which gives communities the power to make capital decisions based on reputation and relationships, creating systems where borrowers and lenders can take a collaborative approach to setting terms, dealing with adverse circumstances, and working out problems.
Common Future network leaders are at the forefront of working to test and implement both of these approaches. The Working World, led by Common Future Fellow Brendan Martin, has lent over $4 million in structures that build in flexibility and shared success.
Common Future Fellow Jessica Norwood’s Runway Project makes flexible investments in Black-led startups akin to the “friends and family” capital that helped many (predominantly white) entrepreneurs get started.
As mentioned in an earlier installment of this series, many other Common Future network leaders, including Derrick Braziel of MORTAR, Vanessa Roanhorse of Native Women Lead, and Elaine Rasmussen of Social Impact Strategies Group, are working to bring character-based lending approaches to their communities. All of these bold, exciting experiments could benefit from capital from investors who are willing to try viable alternatives to traditional financial structures to help build a more resilient economy.
This is part four of a five-part weekly series where I’ve broken down some of the changes that we need to create a more resilient economy and shared who the visionaries are working to bring them into the world. Read part one, part two, part three, and part five.
