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Micro-lending is the practice of lending smaller sums of money, typically to those who are unable to obtain funding through an established federal institution. Micro-lenders typically don’t request any type of collateral before loaning out the money. For-profit institutions may charge a high rate of interest to mitigate financial risks should the borrower default on their loans.
Micro-lending has had a lot of traction overseas in developing nations, and most are non-profit ventures. Money is lent to people who need it to start a small business in their area. Would-be entrepreneurs can get the cash they need to fill a vital need in the community, and lenders can contribute in their own way to helping individuals find their niche and lead more productive lives.
Who is this business right for?
This business is excellent for those who understand the power of responsible lending. This isn't charity, but it is giving someone else a helping hand when they need it the most. The successful micro-lender will need an excellent balance between helping others and remaining financially solvent.
What happens during a typical day at a micro lending company?
Micro-lenders must do a number of things to prepare to lend money:
- Research target client/demographic
- Screen clients
- Create reasonable billing plans for pay back
- Comply with all state/federal laws for financial lending
- Study lending practices in different areas.
What is the target market?
If you're hoping to make a social contribution as much as an economic one, an ideal person to lend a small sum of money to may be a woman in a third-world country, for example. She may be smart and capable of running a small family farm, but she lacks the resources to get started. A small sum of money may buy her enough for a few animals, which she can then raise to provide for her family. She may use the milk from goats or eggs from chickens to both nourish her family and sell to others in her community.
If you're hoping to make money on your loan, you may want to consider lending to young go-getters who lack the credit history they need to get a conventional loan. There are a number of reasons why people may need a small amount of money, so do your research first before you decide which areas need your assistance the most.
How does a micro lending company make money?
Micro-lenders make money by charging people interest on their loans. You may lend out $500 at a 20% interest rate, meaning the debtor will owe $600 by the time all is said and done.
What is the growth potential for a micro lending company?
Micro-lending has done well in Latin American countries and third-world nations because there are a limited amount of ways to obtain conventional funding. If you wish to open a for-profit business, you may want to concentrate on these areas as opposed to lending within the US.
What are some skills and experiences that will help you build a successful micro lending company?
Having some type of formal education in how finances work around the world will help, as will an in-depth knowledge of current law for both the country you operate out of and the country of those you’ll be lending to.
What are the costs involved in opening a micro lending company?
Micro-lenders typically don’t have a lot of overhead, though you’ll likely need to hire a loan processor, a collector, and a bookkeeper. If you plan to take on all of these roles on your own at the beginning, you'll need to be extra careful. Even one mistake on your part can land you in legal hot water.
What are the steps to start a micro lending company?
Once you're ready to start your micro lending company, follow these steps to ensure that your business is legally compliant and avoid wasting time and money as your business grows:
- Plan your business. A clear plan is essential for success as an entrepreneur. A few important topics to consider are your initial costs, your target market, and how long it will take you to break even.
- Form a legal entity. Establishing a legal business entity prevents you from being personally liable if your micro lending company is sued.
- Register for taxes. You will need to register for a variety of state and federal taxes before you can open for business.
- Open a business bank account. A dedicated checking account for your micro lending company keeps your finances organized and makes your business appear more professional to your customers.
- Set up business accounting. Recording your various expenses and sources of income is critical to understanding the financial performance of your business. Keeping accurate and detailed accounts also greatly simplifies your annual tax filing.
- Obtain necessary permits and licenses. Failure to acquire necessary permits and licenses can result in hefty fines, or even cause your business to be shut down.
- Get business insurance. Insurance is highly recommended for all business owners. If you hire employees, workers compensation insurance may be a legal requirement in your state.
- Define your brand. Your brand is what your company stands for, as well as how your business is perceived by the public. A strong brand will help your business stand out from competitors.
- Establish a web presence. A business website allows customers to learn more about your company and the products or services you offer. You can also use social media to attract new clients or customers. Save 15% when you create a business website with Weebly.
Select your state below for an in-depth guide on completing each of these steps in your home state.
Where can I find a business mentor?
One of the greatest resources an entrepreneur can have is quality mentorship. As you start planning your business, connect with a free business resource near you to get the help you need.
Having a support network in place to turn to during tough times is a major factor of success for new business owners.
What are some insider tips for jump starting a micro lending company?
The best thing you can do is learn how to screen your clients, and to create detailed contracts about each loan. You will get a lot of applications from hard-working, responsible people who will do everything possible to use the funds wisely and pay you back. However, you will get a certain amount of people who are out to take your money, or who are asking for the money to achieve an unattainable goal. Consider video chat or in-person meetings as a way of getting to know your clients. Ask them about their business plan, and look to see how much effort went into their model.
You also need to keep meticulous records to ensure you’re never in danger of violating the laws. Start with sketching out a business plan that details how each transaction will work, and how everything will be recorded. Owners also need to have enough capital to start the business. Even with a limited amount of clients at the beginning, all of your loans will add up quickly.
How to promote & market a micro lending company
The best way to promote and market your business is to understand the need you’re filling in any given area. For example, if you’re only targeting small family farmers, then you need to determine how they learn about financial opportunities in their area. This may include physical advertising, such as flyers, or online advertising on specific websites. Depending on your goals, it may even include going door to door.
You should also have your own website that describes what you do, and how you do it. Consider having your information in several languages for the best results, and hiring an interpreter for better communication.
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How to keep customers coming back
The best way to generate customers is to be as fair a lender as possible. This doesn’t mean letting people get away with constantly missing payments, but it does mean trying to work with your clients whenever possible. Always do what you say you're going to do, and ensure excellent customer service and professional behavior at all times.
How and when to build a team
Those familiar with the micro-lending business say to hire people right away, because the risks of making a mistake can be high. However, if you’re starting small with just a few clients or you don’t have very much capital, you may be able to get everything started without external help.
State & Local Business Licensing Requirements
Certain state permits and licenses may be needed to operate a micro lending business. Learn more about licensing requirements in your state by visiting SBA’s reference to state licenses and permits.
Most businesses are required to collect sales tax on the goods or services they provide. To learn more about how sales tax will affect your business, read our article, Sales Tax for Small Businesses.
For information about local licenses and permits:
- Check with your town, city or county clerk’s office
- Get assistance from one of the local associations listed in US Small Business Associations directory of local business resources.
Maintain Personal Asset Protection
Don’t think that just forming an LLC, or any other type of business, will save your personal assets in case of a lawsuit or other matter by itself.
When your personal and business accounts are mixed, your personal assets (your home, car, and other valuables) are at risk in the event your LLC is sued. In business law, this is referred to as piercing your corporate veil.
Two of the simplest steps that will protect your business, and yourself, are to:
Open a business bank account
- This separates your personal assets from your company's assets, which is necessary for personal asset protection.
- It also makes accounting and tax filing easier.
Get a business credit card
- This helps you separate personal and business expenses by putting your business' expenses all in one place.
- It also builds your company's credit history, which can be useful to raise money and investment later on.
Certificate of Occupancy
Businesses operating out of a physical location typically require a Certificate of Occupancy (CO). A CO confirms that all building codes, zoning laws and government regulations have been met.
- If you plan to lease a micro lending office location:
- It is generally the landlord’s responsibility to obtain a CO.
- Before leasing, confirm that your landlord has or can obtain a valid CO that is applicable to a microlending business.
- After a major renovation, a new CO often needs to be issued. If your place of business will be renovated before opening, it is recommended to include language in your lease agreement stating that lease payments will not commence until a valid CO is issued.
- If you plan to purchase or build a micro lending office location:
- You will be responsible for obtaining a valid CO from a local government authority.
- Review all building codes and zoning requirements for your business’ location to ensure your microlending business will be in compliance and able to obtain a CO.
How much can you charge customers?
Interest rates vary widely from place to place. Some may charge 10% while others charge up to 80%. The average is about 35%, but you’ll want to to do research on the interest rates in any given area. Some well-known, non-profit micro-lending websites don't even offer the option of interest, while others may go as low as 3%. In these cases, it's more like charity than a business venture though. Those who charge extremely high interest rates are usually for-profit businesses.
What are the ongoing expenses for a micro lending company?
Overhead for a micro-lender is low, as you generally don’t need an office to conduct business:
- Employee salaries
- Advertising costs
- General office supplies
- Website costs
How much profit can a micro lending company make?
With persistence and patience, a micro-lender can make a considerable amount of money when in the right area. Some studies state that up to 97% of low income borrowers pay back their loan under the agreed upon terms. If you make $100 on average on each loan, you’ll need to make 600 loans in a year to make $60,000.
How can you make your business more profitable?
You may wish to expand to other parts of the world to make your business more profitable. Or you could consider opening up a payday loan store in your neighborhood if you feel you have a good handle on micro-lending, and want to serve others who may need financial assistance.