Banks continue to provide most of the credit assets for small businesses, but new funders are on the rise. In addition to Community Development Financial Institutions and credit unions, which have been around for years, small businesses can now turn to emerging online funders. These funders offer small businesses new opportunities for accessing capital. They also provide a superior customer experience, more transparency and, with BizFund, speedy funds delivery.
The Growth of Online Funders
Online funders enjoy an outstanding portfolio that has been growing at approximately 175% a year. Altogether, they provide small businesses with a funding capital of around $10 billion. By contrast, banks are facing a 3% decline in their outstanding portfolio, even though they provide $700 billion in loan capital.
Online funders have experienced a rapid rise in popularity among small businesses during the recession. This was even more pronounced during the economic recovery that followed. They have been around for more than 10 years but have gained momentum in the last few years.
Why Online Funders
Small but innovative, online funders seem to be changing the face of the financial sector. A key factor responsible for their growth are high rates of return, which can reach 30-120%. These have attracted both equity and institutional debt investors.
Another factor is the simpler application process that alternative funders are providing. Instead of spending hours completing paperwork for a traditional bank loan, small businesses can now use online applications, which can take less than half an hour to complete. Available on both desktop and mobile, they can make approval a question of hours.
Once its online application is accepted, a small business doesn’t have to wait weeks for financing. Nor does it have to go through a specific procedure to obtain the money. It can receive funds straight into an account in a matter of days.
Types of Online Funders
Online funders differ from banks in their application reviewing process. In addition to the owner’s credit history and key business metrics, the funders use other methods and data sources. These may include data aggregation, electronic payment technology, and predictive modeling. All of these assist in assessing the business performance of applicants.
Online funders also use cash flow and business performance metrics to determine risks. Often, these are derived from nontraditional data sources. The new technology that online funders use is representative of their way of doing businesses.
Balance Sheet Funders
Online balance sheet funders like Kabbage and OnDeck Capital provide short-term loans for inventory and working capital. Similar to a merchant cash advance, they deduct a fixed sum from the borrower every day. At OnDeck the average loans are $40,000. These loans come with 50% rates on average, but may be as high as 120%.
Peer-to-Peer Funders
Other online funders rely on individual investors to provide a peer-to-peer credit model. Alternative funders such as Lending Club, Funding Circle, or Prosper offer amortizing loans and fixed interest rates. These range from 8-24% for three-year loans of up to $250,000. Also, these lenders use propriety credit models.
Funding Market Brokers
Yet another generation of alternative funders have created their own loan markets. Lenders like Fundera, Lendio, or Biz2Credit aggregate offers from balance sheet lenders and community banks. They can bring borrowers a diverse portfolio of choices.
At the same time, they reduce the search cost usually associated with finding a loan. They make money by charging a small fee on top of the loan.
New Funders Versus Old Funders
These new types of lenders are filling the gaps in the standard small business lending model. They are not only becoming a viable alternative to traditional lenders, but also a possible challenge. The $4 billion IPO valuation of Lending Club, and an anticipated valuation of $1.5 billion for OnDeck cannot leave big lenders indifferent.
For small businesses, online lenders balance higher interest rates with faster applications and lower search costs. They also promise better customer support and pricing transparency.
However, credit card companies and established banks could themselves adopt the technologies new lenders have introduced. In addition to a wealth of borrower data and long lists of small businesses seeking loans, banks also have solid balance sheets. They could use these to challenge online lenders in the new marketplaces they have created.
Reasons for Optimism
In a world where small business funding has yet to return to the levels before the economic crisis, new funders can change the game. They bring new opportunities to small businesses, which can secure funds more quickly. At the same time, however, the policy and economic challenges they create cannot be easily ignored. Not in the light of the past financial crisis.
During this time of transition, the alternatives that online funders offer can be appealing to many small businesses. Driven by technology and innovation, small business funding could be undergoing a positive change. There’s no denying that many small businesses have embraced online funders.
Online funders can offer small businesses fresh reasons to be optimistic. They could help provide them with the capital they need to grow, and then sustain their development. By doing so, they may even drive the growth of the country’s economy.
