There have never been so many loan options, at the bank or online, for small business owners. But which ones are best?
If you're a small business owner, you've probably wrestled with the challenge of getting the financing to expand your business, to get the equipment or floor space you need to reach your goals, to make the leap to the next level. It used to be that, if entrepreneurs wanted this kind of financing, they had few options. Local banks. Their Uncle Ricky. That shady guy in the Chevy Monte Carlo.
Now, the Internet, as with so many other industries, has brought a host of new loan options for small businesses. With peer-to-peer lending sites like Lending Club, entrepreneurs can cut out the middle man and borrow directly from individual investors. Online balance sheet lender sites like Kabbage offer their own brand of small business loans. And finally, online marketplaces like Lendio and Fundera let entrepreneurs comparison shop offers from a bunch of lenders at once.
But are online small business lenders fundamentally better for entrepreneurs than the bank or credit union around the corner?
It depends on your situation as a small business owner. This article will walk you through the pros and cons of traditional and online small business loans so you can make the smartest financing decisions for your fledgling company.
No one is going to argue that traditional banks are the best when it comes to providing lots of loan options for small business owners. A visit to one bank may yield two or three loan options at the most; if you want more options, you've got to visit multiple banks to get a range of options with which you can feel comfortable.
Contrast that to almost any online lender. An application on one site can yield a dozen different loan options to choose from. And then there are a host of different types of small business loans you can access online, as mentioned above.
Hands down: online small business lending presents entrepreneurs with far more choices and flexibility than they've ever had with traditional banks.
By its very nature-as in, all one has to do to access it is type in a website URL into their browser-online lending wins the content of "Most Convenient" without even trying. In fact, the difference between the time it takes to submit a loan application online versus at a bank is just plain ridiculous. Remarks Forbes contributor Karen Mills:
"[M]any of [the online loan applications] can be completed in under 30 minutes. These are not just inquiries; these are actual loan agreements. This compares to the average of about 25 hours that small businesses spend on filling out paperwork at an average of three conventional banks before securing some form of credit, according to the Federal Reserve Bank of New York's Fall 2013 Small Business Credit Survey."
Filling out an application is one thing, but having money in hand is what really matters to small business owners. Waiting for an application to be processed and to be notified of whether you're approved or not can make an already arduous process unbearable.
So, naturally, small business owners are going to most appreciate that lender who can get them an answer sooner, saving them from the displeasure of waiting on pins and needles-and leaving their business hanging in limbo at the same time.
According to the same Federal Reserve survey, says Mills, "Upon filling out an online application, owners can be approved in hours and have the money in their account in just days, whereas in the conventional banking model small business owners may not be approved for several weeks."
Online small business lenders, unencumbered by much of the paperwork and bureaucracy that clutters traditional lending, can just cut to the chase a lot quicker. Whether approved or denied, faster decisions mean entrepreneurs can stop waiting and start moving forward with their plans.
Speaking of decisions, we're all somewhat familiar with how traditional banks decide whether or not to extend financing to small businesses. They look at your credit history, your business' cash flow, revenue, and projections. They look at your product/services and the way you organize your business. Although they can't say it out loud, they also throw into the mix their gut feeling about you as a person. Then out of all that, they come to a decision of whether they want to finance your operation, how much they can loan you, how high of interest they want to charge, etc.
Online small business lenders are decidedly more, um, robotic. Yes, they take into account credit history and cash flow, but their formidable array of predictive modeling, data aggregation, and electronic technology also crunches a ton of other data to decide whether you're worth investing in. It assigns you a risk score based on your industry, where you operate, the size of your market, your education level, and more. It also looks at your social footprint for other signs of risk (Ex: bad reviews on Yelp, if you're a restaurant owner).
As uncomfortable and risky as getting a traditional small business loan can seem, getting a loan online is definitely a colder, more calculating experience. Online, no amount of spunk or confidence is going to tip the scales in your favor. Instead, your financial future is in the hands of an algorithm (more about this later).
Wonder what the catch is for online small business loans? Interest rates are one place where you start to see the tradeoffs for all that convenience and selection.
According to Bloomberg Businessweek's July rate report, small business loans under $100,000 see interest rates of 7 to 8 percent and those over $100,000 see lower rates of 6 to 7 percent.
Unfortunately, online small business lenders can't quite match this. "Many alternative lending platforms charge yields ranging from 30 to 120 percent of the loan value, depending on the size, term duration, and risk profile of the loan," says Mills.
In contrast, according to a recent breakdown on NerdWallet of Kabbage's loan offerings, a $10,000, six-month loan will end up with an APR of over 40%. That's not quite payday loan territory, but it blows away the interest rates of the worst credit cards.
Lending Club, despite its advertised "low, fixed interest rates starting at 5.9%," still ends up delivering APR somewhere in the neighborhood of 8 to 32 percent, after fees.
After their one-time origination fee, repayment schedule, and daily compounding of interest, OnDeck charges a truly frightening APR of 49 percent on an average loan.
All of this points to the indisputable conclusion that small business owners would do well to first seek a bank loan and then, if that search proves fruitless, to consider their online options.
The evidence against bank's treatment of minority and female small business owners is piling up. Studies have found that, even with all other factors equal, Hispanic and black small business owners receive fewer loan offers, for smaller amounts, and with worse rates. They also tend to receive lukewarm customer service at banks. A 2013 study confirmed that these same groups were less likely to to be approved than whites. Female entrepreneurs have experienced similar treatment from banks.
With such poor treatment from banks, online small business loans seemed like an opportunity to rectify this inequality and truly lend money without regard for gender or race (as they're supposed to). After all, if a bank couldn't see your face, maybe minority and female entrepreneurs finally had a shot at getting the same loans their white male counterparts got.
This hope, unfortunately, is rapidly fading in the face of reality. It's not clear if small business owners are any better off borrowing money with online lenders than they would be with a traditional bank. And cold, calculating machines might be to blame.
Steve Lohr at the New York Times explains the problem thusly:
"By law, lenders cannot discriminate against loan applicants on the basis of race, religion, national origin, sex, marital status, age or the receipt of public assistance. Big-data lending, though, relies on software algorithms largely working on their own and learning as they go. The danger is that with so much data and so much complexity, an automated system is in control. The software could end up discriminating against certain racial or ethnic groups without being programmed to do so."
In other words, even if minority and female small business owners can escape the discrimination of loan officers and branch managers at banks, they might find the super-algorithms of Lending Club and Prosper discriminating against them anew.
Obviously, the choice between a traditional or an online small business loan is far from cut and dry, and your choice will really depend on your situation. It is clear, however, that every small business owner should try to secure a traditional bank loan because of the lower interest rates and fees involved. If you find that your credit history, financials, gender, or race disqualify you for a traditional small business loan, then seeking a loan through Kabbage, Lending Club, Prosper, or another online lending site is your next best option. Thankfully, you unlike entrepreneurs of even a decade ago, now have this second option.
Ready to apply for a business loan online? See how the top online small business lenders stack up in terms of requirements and rates on our "Best Business Loans" page!