Small businesses’ cries for financing are being heard. Not by traditional banks, but instead by an array of online financing organizations that use technology and data to speed money to borrowers. While these new options can be more expensive due to the greater risk they undertake, these lenders ultimately make more money available to a greater number of businesses.
Even before the 2008 recession, banks were starting to focus on providing $1 million-plus loans to mature businesses. This only accelerated when the recession began, which left other companies to seize an opportunity to provide startup and small loans to growing businesses.
Online alternative lenders do more than fill a void left by banks. They also increase the likelihood that a small business will qualify for a loan. “New and seasonal businesses, businesses with lumpy cash flow and even owners with a black mark on their personal credit are getting approved by online lenders,” says Candace Klein, chief strategy officer of Dealstruck, which provides mid-term loans and lines of credit to businesses that are at least a year old and have some traction, but may not yet be profitable.
Banks require that you meet high standards for cash flow, credit score and collateral. “You need to have a check mark next to all three for a bank loan,” according to Brock Blake, CEO and co-founder of Lendio, an online service that matches small businesses with loans. By looking at more types of data, online lenders can lower the bar in one or two categories if the applicant ranks highly in another.
Alternative online lenders go beyond looking at just profitability as a measure for cash flow. They look at the transaction history in your bank account, credit card swipe and shipment activity, and volume of invoices in accounting software programs, like QuickBooks.
They also take an alternative view of collateral, which can take more forms than just a home, real estate and machinery. Some online lenders will consider luxury assets such as a high-end watch or painting. Even people with a low personal credit score may qualify for a loan from an online lender if they have collateral or their business has cash flow.
An Expedited and Streamlined Loan Process
A tidal wave of alternative lending companies is entering the market to meet the needs of different market segments, which can make the abundance of options appear confusing to a small business owner. These include services like Biz2Credit, Fundera and Lendio, which analyze a potential client’s financing needs and its vitality to match it with the best financing options, including traditional bank loans.
They also streamline the overall process of applying for a loan by enabling borrowers to use a single application for multiple lenders. Some online lenders even make loan decisions in minutes, versus weeks for banks.
When a company needs financing, it frequently can’t wait the three to four weeks a bank may take to approve a loan, says David Ehrenberg, founder and CEO of Early Growth Financial Services, which provides outsourced CFO services to technology companies. Even when a small business knows that waiting a few weeks means likely approval for a cheaper loan, it ends up going with the online lender, according to Blake.
A Lender for Every Market Segment
Depending on the type (e.g. business-to-consumer, business-to-business) and stage (e.g. startup, early success, sustained success, rapid growth or mature) of your company, different lenders will be right for your company, says Dealstruck’s Klein.
If you have early success and aren’t yet profitable, Can Capital, Kabbage and OnDeck may be a fit. If you have sustained success for a year or more and aren’t yet profitable, Dealstruck, Fundation and Funding Circle may be right for you. If you have rapid growth and are profitable, Lending Club or even a traditional loan may be the answer.
Business owners who don’t qualify for a bank loan should apply for an SBA-backed loan, says Klein. It will be cheaper than online alternative loans. She warns, however, that the SBA process can take six to eight months. An online alternative loan can bridge the gap.
Small Business Borrowers’ Bill of Rights Seeks to Protect Borrowers
Few regulations currently exist to protect small businesses from predatory lending, but some in the industry recognize the importance of standardizing best practices. The Responsible Business Lending Coalition has adopted guidelines—its Small Business Borrowers’ Bill of Rights—meant to foster greater transparency and accountability. The guidelines outline six key rights:
- The Right to Transparent Pricing and Terms, including a right to see an annualized interest rate and all fees
- The Right to Non-Abusive Products, so borrowers don’t get trapped in a vicious cycle of expensive re-borrowing
- The Right to Responsible Underwriting, so borrowers are not placed in loans they are unable to repay
- The Right to Fair Treatment from Brokers, so borrowers are not steered into the most expensive loans
- The Right to Inclusive Credit Access, without discrimination
- The Right to Fair Collection Practices, to prevent harassment and unfair treatment
If you are considering an online alternative funder, familiarizing yourself with these rights can help you form questions to ask which to evaluate a potential lender.
Options in Addition to Debt
Small businesses do have other funding options apart from taking on debt. Crowdfunding pools money from a group of people via online platforms, using social and traditional media. Two types are relevant here:
- Rewards-based crowdfunding: Funders receive a tangible item or service in return for their money. Some businesses collect the cost of the item from customers before manufacturing the product; others beta test products or raise money in exchange for a token gift. Websites, such as Indiegogo and Kickstarter, coordinate the transactions. A rewards campaign can provide seed money, augmenting the resources invested by founders, friends and family.
- Equity-based crowdfunding: Investors receive a stake in the company. There are currently two options: Title II, Regulation D and Title IV, Regulation A+ of the JOBS Act. This article clarifies some common misconceptions about Title II crowdfunding. Platforms that specialize in Title II include CircleUp, Crowdfunder and SeedInvest. Platforms that specialize in Title IV include SeedInvest and StartEngine.
Whether you pursue rewards-based or equity crowdfunding, these tips can ensure your crowdfunding campaign’s success.
Banks aren’t going away. A bank is where you still deposit your money, and likely where you’ll find cheaper long-term financing as your company grows and matures. In the meantime, online alternative lenders can offer speed and flexibility. They can get you from where you are now to the point at which you can take advantage of traditional lending options.
If you’re thinking of skipping loans altogether, read Geri Stengel’s advice on equity startup financing.