It was Friday afternoon when Bob received the call from his bank telling him that he had been turned down for his $250,000 loan request. He had purchased a second location as part of his business expansion plans and needed the bank loan to purchase inventory for his new location.
Bob was devastated.
Why had it taken over two months for the bank to say no? The bank’s reason for turning down the loan request was that they were not comfortable making an inventory loan of that size. He couldn’t understand why the bank wouldn’t work with him. He had good credit. The business was profitable, and it had shown solid growth for over 10 years.
Worse still, time was running out to purchase the inventory at a steep discount from a competitor going out of business. He needed the money in a week to close the deal. Where could he turn to get a $250,000 loan in a week?
Small businesses are core to America’s economic competitiveness. According to the Small Business Administration, small businesses make up 99.7 percent of U.S. employer firms. Yet in recent years, small businesses have been slow to recover from the Great Recession and credit crisis that hit them especially hard.
For decades, small businesses could only look to traditional banks, credit unions, the SBA, credit cards, or in a few cases, factoring firms, (who purchase your receivables in exchange for immediate cash) to meet their capital needs. Recently, however, a massive wave of new national and highly scalable alternative online lenders (non-bank companies) has entered the market. These alternative lenders offer higher acceptance rates and faster capital deployment (one to 14 days) than traditional lenders, and as a result, have seen tremendous growth in the market over the past five years. The alternative-lending industry now stands at $1 trillion dollars, according to CrunchBase, which monitors public and private companies globally.
In a recovering economy where big banks are restricted by complex regulations (Dodd Frank), small businesses are turning to alternative lenders that are upending banks’ conservative lending standards by automating loan approvals. Instead of relying on collateral and credit scores, these cash-flow lenders use software that reviews online sales, banking transactions and comments on social media sites among other criteria, to make loan decisions within minutes instead of weeks or months.
With most alternative lenders, borrowers apply for loans online and usually receive an answer the same day. If approved, funds are available anywhere from a day up to a couple of weeks, depending on the size of the loan.
Alternative lenders generally fall into two categories: (1) peer-to-peer lenders like Lending Club, Funding Circle and Prosperous, which raise funds from groups of investors that lend money to businesses from individual investors or (2) direct lenders like On Deck, Kabbage and Balboa, which lend money to businesses from funds raised by institutional investors.
Alternative lenders make loans from $2,000 to $5 million for all kinds of business needs. Loan types include purchase order financing, export financing, inventory purchasing, equipment purchases or leasing, credit insurance, cash advances, working capital, lines of credit and growth and expansion plans.
While specific statistics are hard to pin down, there are about 1,300 alternative lenders. They compete for about 1 percent of the overall credit market, compared to about 6,500 traditional banks competing for the remaining 99 percent. Banks decry these loans and insist that the alternative lending industry is serving what traditional banks call “unbankable loans” – loan requests that commercial banks will not consider.
Since the alternative lending market is becoming overcrowded, it is hard for these companies to differentiate themselves. In turn, it is easy for a borrower to become overwhelmed when searching for the best provider. Nearly all the alternative lenders inundate potential borrowers with a strikingly similar array of direct mail, email and online advertisements. Most of these lenders make credit decisions and approve loans in the same amount of time, have similar costs of capital and charge roughly the same rates. Moreover, most lenders have nearly identical customer acquisition costs, ranging from around $2,500 to $3,500 per loan. All alternative lenders position themselves for fast approvals, fast funding, flexible terms, little paper work and loans that can be unsecured.
Most loans come with hefty fees and high interest rates that can carry effective annual percentage rates (APRs) from 20 percent to 60 percent, according to USA Today. By comparison, bank interest rates for similar loans average 4.5 percent to 6 percent. However, some alternative lenders will lend at rates as low as 11 percent. Many of these loans can be subordinated to other debt the business is carrying and require no personal guarantees. Also, less-than-perfect credit is rarely a deterrent to receive a loan.
Repayment and other terms and conditions are often quite flexible, ranging from three months to three years. Loans can be repaid on a daily, weekly or monthly basis.
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Lending alternative companies are emerging as a dynamic and disruptive force using sophisticated technology to address the needs of the small-business lending market. Though small compared to the traditional bank market, these new competitors are providing fast turnaround and online accessibility for customers, and are often using data to create more accurate credit scoring algorithms than traditional banks.
There are pros and cons in seeking a loan from an alternative lender, so I advise clients who are having problems with traditional lenders to examine alternative lenders carefully. Examine the details of the loan terms, conditions and covenants. Make sure your company can service the debt. If cash flow is a problem, seek professional advice from your accountant or other advisers before signing the dotted line.
That’s what Bob did. I advised him to find an alternative lender for the $250,000 he needed to purchase the inventory for his new location. All ended well for Bob. The alternative lending market is one answer to filling the credit gap for small businesses like Bob’s.
If you need a loan, alternative lending sources are worth a serious look.
Gary Miller is the CEO of GEM Strategy Management, Inc., an M&A consulting firm, advising middle-market private business owners prepare to raise capital, sell their businesses or buy companies. He is a sought-after business consultant and speaker on M&A issues, strategic business planning, business valuations, exit planning, family transfers, what buyers are looking for in acquisitions and how to prepare for due diligence. He can be reached at 970-390-4441 or gmiller@gemstrategymanagement.com.
