Small businesses are the backbone of the US economy, with 23 million accounting for 54 percent of all US sales. Yet, as vital as they are to the US economy, small businesses, especially the newer ones, often find it difficult to secure loans or lines of credit from banks. In January of 2014, Biz2Credit reported that big banks approved less than one-fifth of SMB loan requests.
However, there are now other ways these SMBs can get the money that they need. Alternative lenders aim to help businesses that do not qualify for bank loans due to strict underwriting requirements, but have viable businesses.
Alternative lending is doing well, first, because the groundwork for today’s SMB-lending is “inefficient,” says Forbes. The way in which traditional lenders connect with borrowers isn’t working – and regulations only serve to make things more difficult. In addition, a lot of bankers “arenot really interested in any real innovation in small business lending.”
In March, the New York Times reported on several alternative types of lending and how they are gaining popularity. According to the article, Ivan Rincon, owner of the Miami swimwear store Orchid Boutique, first turned to a merchant cash advance provider, which lends quick cash to businesses in exchange for a share of future sales, when he couldn’t get a business bank loan. This left him paying off more than a 50 percent yearly interest rate – which, he admitted, may have been a wrong move for the company. Mr. Rincon used a new service called Dealstruck’ which loaned him $250,000 over a three-year term – at an interest rate of only 10 percent.
Dealstruck isn’t the only new alternative business lender out there – PayPal Working Capital, which launched in the Fall of 2013, takes repayment as a fixed percentage of sales each day which offers a convenient and predictable repayment schedule for both PayPal and the business. PayPal is lending $1 million a day and says that the average interest rate is less than 10 percent. Kabbage, Inc., an Atlanta tech-based lender founded in 2005, has funded over $200 million to help businesses grow, according to its website . Kabbage in particular uses businesses’ seller history and reviews, using innovative technology to analyze sales data to determine how much to lend over what length of time. Fundation, another tech-driven lending platform founded in 2011, provide funds for businesses that “deserve a better product but don’t qualify for a bank,” said CEO Sam Graziano in the article. And, Square Capital operates in much the same way as PayPal Working Capital does, and claims to have loaned millions to thousands of its merchants.
SMBs that canot get bank loans also have the option of going with peer-to-peer lending (P2P), using various websites like that follow a “crowdsourcing” method, offering lending tools and platforms for businesses to connect to large groups of possible lenders. The interest rates are set by lenders, or may be fixed by intermediary companies based on the borrowers” credit. One such P2P lending platform, Lending Club Corporation, has made more than $4 billion in loans and is on the path toward going public, anticipating an IPO that could make as much as $500 million.
With CoreCard’s configuration of credit decision rules, “One customer can be offered multiple loans with different payment terms from the same account providing the lender opportunity for new revenue without losing sight of the borrower”s credit limit,” says the CoreCard website. “A client has offered more than 100 loans to a business borrower with single account on our system.” Interest rates can therefore vary depending on the alternative lending company and the business receiving the loans – they are not always low rates.
A criticism is that alternative lenders do much of the same thing as those who give merchants cash advances. A percentage of sales is deducted daily from the business’s bank account, and due to the short loan terms, SMB borrowers could have to pay more than 50 percent yearly without knowing, says the NYT. While these rates have allowed these alternative lenders to grow and lend to more companies, borrowers need to be on the lookout for inexplicably high mark-ups and predatory consumer lending in order to avoid getting over their heads.
Alternative lenders are using technology in new and different ways to help with the underwriting and risk management process. For example, Google Street View can help them determine whether the business, in fact, in business. Applications are done digitally and customer algorithms that go consider other data well beyond simply looking at a FICO score can often mean the difference been being approved and declined, while keeping the cost of serving that customer down.
So how has alternative lending affected the overall space? WHEN, alternative lenders accepted around 64 percent of SMB loan requests received, according to Biz2Credit. And, even traditional banks are coming around in part because they have better tools now to help them “grow their small business portfolios,” as well as better manage them, according to Experian. Small business cards, for one, have become increasingly popular, a trend that arose during the economic turnaround and personal credit cards have always been an important part of the small business capital portfolio.
Many of the big banks are setting aside capital to loan to SMBs. Wells Fargo announced that it is allocating $100M just for SMBs over the next few years. Chase has launched its “Mission Main Street” initiative that is focused on investing in local businesses and local markets. And, BBVA has partnered with alternative lending, OnDeck, so that they can serve a customer that their more traditional underwriting requirements would not permit. OnDeck analyzes thousands of data points, from cash flow to public records to social data, to assess the health of a small business. BBVA will use the OnDeck Score and technology to provide businesses with loans of up to $250,000. And smaller banks, like Celtic Bank, which tend to approve a higher percentage of small business loans anyway, are putting forth an effort to limit SBA loan process for loans under $150k to a much shorter period of time.
When it comes down to it, with alternative lending on the rise and SMBs more easily getting the capital they need, Forbes says traditional lenders must “innovate or run the risk of becoming irrelevant.”