The small business lending landscape is changing. According to a 2014 report from Ernst & Young, "nearly one in five [small businesses] reports having changed its primary bank in the past year." The reason: access to capital; an increasing number of small business owners feel they can no longer rely on traditional lending channels to provide needed funds-regardless of a long-standing history with the bank or other provider.
And the feeling is mutual; not only are small business owners departing from traditional lending routes, but banks are also losing interest in lending to small businesses, in favor of larger corporations with greater borrowing potential. Not to say the demand for small business loans isn't there; it's the supply of traditional lenders that's running out. For example, in 2013, the Small Business Administration only approved 13 percent of applicants seeking a small business loan.
The lack of response from traditional lenders has opened the door for a number of alternative lenders to pick up the slack. This group includes venture capitalist firms, peer-to-peer lenders, direct lenders, and crowdfunding. Companies like CAN Capital, OnDeck, and Lending Club are also meeting the demand of small business borrowers by providing more flexible terms, and faster access to capital.
To be clear, not all banks offer unreasonable terms meant to deter small businesses; in fact, banks tend to offer much lower interest rates than alternative lenders. But interest rates aren't everything. In fact, more and more small businesses are willing to absorb higher interest rates in exchange for these other perks offered by alternative lenders:
One area in which alternative lenders are literally outpacing traditional banks is in how fast they can transfer funds to their customers. The top business lenders have streamlined every step of the process by shifting their platforms online. Now, rather than filling out stacks of complicated forms and paperwork, customers can answer a series of simple questions about themselves, their business, and the size of the desired loan; instead of waiting months just to see if they've been approved for a loan, borrowers can know within hours, and receive funds within days-not months.
According to an article from NerdWallet, the process of applying for a bank loan for your business can be both lengthy and complicated. "Expect to spend 25 hours or more just taking care of the necessary paperwork," the article warns. Borrowing through an alternative lender, meanwhile, can take as little as 10 minutes.
NerdWallet also estimates that borrowers will have to wait anywhere from two to six months for a bank to both approve the loan and disburse the funds. According customer data from one alternative lender, some customers achieved pre-qualification status within a hour, and customers on average will receive funding in as little as 11 days.
One of the main reasons why alternative lenders can get funds to borrowers faster is because of their less stringent applicant requirements. Since the 2008 recession, banks have upped their lending restrictions so as to only approve what they consider "low-risk" borrowers. This status applies to business owners with excellent credit, whose businesses are well established and not struggling financially. By this standard, many small businesses are considered high-risk, and will have no success obtaining a loan though traditional means.
Alternative lenders have remedied this problem by offering lower requirements and more flexible terms, the tradeoff being they charge higher interest rates than traditional banks.
To receive a small business loan from a bank, you need excellent personal credit. Maintaining good credit indicates to lenders that you are a reliable borrower, that you'll pay off your loan within the terms set by the lender. Business Finance says a credit score of 800 will get you a loan practically everywhere; 700 is considered ideal by most banks; and most banks will not approve an application for anyone with a credit score less than 640.
On the other hand, alternative business lenders provide options to borrowers with personal credit scores as low as 550-some will even provide working capital loans to borrowers with a score of 500.
It's no secret to those in the small business realm that a significant portion of small businesses will fail within the first few years. The SBA reports that half of businesses will fail in their first year. One of the main contributing factors to this statistic is the fact that business owners are poor money managers; they can't pay their bills, or they invest their capital in areas that don't produce scalable results. Not surprisingly, traditional banks see businesses that have been around for at least two years as good investments, and younger businesses as statistically bad investments.
Not the case with alternative lenders. The top business loan providers will offer options to businesses at nearly every stage of their development. Many of these companies provide terms to businesses as young as four months!
Another important metric banks look at before approving a loan application is how much revenue your business brings in. Simply put, the more money your business makes, the more you can borrow, and the more money the bank will be able to collect in interest. A report from Inc.com claims that in order to qualify for a typical bank loan for your small business, you'll need to be making at least $250,000 in annual revenue-not exactly an obtainable figure for many new businesses.
Alternative lenders, meanwhile, will accept applicants with limited resources; and while no company can offer a term loan to a business with anything less than $100,000 in annual revenue, they do provide merchant cash advances to companies that make at least $55,000.
Speaking of lower lending requirements, a big reason why alternative lenders are becoming a more attractive option is that few of them require collateral. Simply put, collateral is an asset the borrower promises to give the lender in the event that the borrower cannot pay back the loan. There are two types of collateral a bank may require you to borrow against before you can qualify for a loan: personal collateral refers to an asset such as a home or car that can be transferred to the bank and sold; business collateral refers to assets directly associated with the business.
Nearly every bank requires some type of collateral before approving a loan. For example, Wells Fargo and Bank of America both require business collateral, while KeyBank requires both business and personal collateral. Meanwhile, top alternative lenders require zero collateral.
While dedicated small business lenders are a good alternative to traditional banks, not all alternative lenders are created equal. Some lenders, while offering flexible terms, will also charge hefty origination or prepayment fees. You'll also need to pay close attention to the lenders cents on the dollar, as well as your overall likelihood of getting approved. For a full list of the top small business lenders in the industry, click here.
August 17th, 2022
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