Businesses at every stage need capital, and a new technology-driven trend makes it faster and easier than ever before to borrow funds to fuel growth.
A new breed of lenders uses financial technology (fintech) to service customers who want funding quickly to invest in their businesses. Fintech also aims to serve those customers who prefer the conveniences a digital economy affords: streamlined loan application processes, quick turnarounds and easy approvals. Whether to fund a web development project, hire a new staff member or pay for new and needed business infrastructure, these financing solutions initially caught on with startups but have gained traction with small and medium-sized businesses of all stripes.
In addition to for-profit lenders, emerging nonprofits have come to the fore, offering microloans to minority-owned businesses. Fintech can be a boon to women-owned businesses, as research by the National Women’s Business Council has shown that women are less likely than their male counterparts to seek business loans and typically ask for smaller amounts when they do.
“Women are appropriately cautious when it comes to credit, but sometimes it’s because they think they don’t qualify,” says Rebecca Harris, executive director of the Center for Women's Entrepreneurship at Chatham University in Pittsburgh. “Products that make the process faster and easier can offer a new avenue for financing.”
Fintech strategies are helping push the entire banking industry, including traditional banks, forward. Consequently, business owners now have more lending options available from a wider array of sources.
Understand Your Options
But are these products right for your business? Alternative lending has a place, says Gavin Geraci, senior vice president and chief operating officer at PNC Business Banking. Business owners should make an informed decision before signing on, however, and part of being informed is making sure you fully understand what options traditional lenders offer.
“Alternative lenders largely compete on simplicity and speed. They’ve identified an unmet need in the small- to medium-enterprise market, which is immediate, pain-free access to short-term working capital with nontraditional repayment options,” Geraci explains. “At the same time, big data and process automation are rapidly evolving banks’ lending models as well.”
Although there are many types of alternative lenders, their products typically feature short terms for small amounts at higher interest rates than conventional commercial bank lenders. In addition, alternative lenders are often willing to service businesses that don’t qualify for traditional credit. That’s because they assess risk factors differently and do not adhere to the same regulatory scrutiny as banks. For example, online business lenders may access a company’s online payment transactions and cash flow via its bank accounts or analyze other digital data points to review a business.
“Often these companies are leveraging bank transactional data for credit decision purposes, something that we as banks have not traditionally relied on,” Geraci says.
While each alternative lender has its own approach to technology, underwriting and repayment, they nonetheless fall into a few basic categories —and many are hybrids of five models:
- Cash-flow lenders: Most alternative lenders fall into this broad category. They use cash-flow measures and other underwriting criteria to determine eligibility. They often rely on business owners’ personal credit scores as well as on online banking, accounting and e-commerce data. Though not a new concept, merchant advances offered by credit card processors fall into this category.
- Peer-to-peer (P2P) networks or marketplaces: The P2P organizations aren’t lenders themselves but vast electronic markets that bring lenders together with borrowers. The network not only handles the transactions, but also assesses borrower eligibility and determines rates.
- Factors: With factoring, lenders advance funds based on the value of future sales. When those sales take place, the lenders get their principal back, with interest. Factoring lenders advance against the value of outstanding invoices, accounts receivable and even government contracts.
- Asset-based lenders: Other fintech companies lend against tangible assets, such as inventory or new equipment — an idea adopted from traditional lenders and now available to small and less established borrowers.
- Nonprofits: Finally, there are nonprofits that operate as lenders, marketplaces or brokers, typically for underserved communities or in specific geographic regions. Grameen America, for example, provides microloans of $1,500, along with education and networking opportunities, to women in poverty. Other examples include Kiva, Accion USA, and many locally based community development financial institutions (CDFIs).
What to Look (and Look Out For)
Given the expanded sources for funding now in the marketplace, the question becomes How does a business owner choose? Here are questions to help you evaluate the options.
1. Does the product match your needs?
Speed and simplicity shouldn’t be the only criteria. First, think about why you need the funds. “The purpose of the loan is very important,” says Fred Dominguez, program coordinator at Credit to Capital of Rising Tide Capital, a nonprofit that provides business development services for underserved communities.
For example, purchasing inventory for an upcoming project, hiring a full-time employee and building a new facility differ as far as collateral, return on investment and when funds become available for repayment.
“Once you know the purpose, you can create a budget for it and allocate funds. I often find that clients need less outside funding than they originally thought once they undergo the budget exercise,” Dominguez says.
2. Can you afford it?
Similarly, if a business needs a loan to bridge a cash-flow shortage, will that shortage be made up in time to repay the loan? If not, is the potentially higher cost of the alternative lending vehicle more debt than you can handle?
In “State of Small Business Lending: Spotlight on Women Entrepreneurs” (updated May 2017), credit marketplace Fundera points to studies indicating that women business owners tend to ask for smaller loan amounts than their male counterparts and may not be as susceptible to red ink. These business owners should consider comparing alternative and conventional solutions.
“If there isn’t an urgent need for cash, take a few more days to see if your company qualifies for a bank loan that may cost less in the long run,” Geraci recommends.
3. Are the terms understandable and acceptable?
One of the most confounding issues with alternative lending is that interest and repayment terms are not as straightforward as with standard bank term loans.
“It can be difficult to arrive at an apples-to-apples comparison,” Geraci says. “Make sure you know the full cost of the loan, including interest and fees.”
Also determine if there is a benefit — or penalty — for early repayment. To help level the playing field for borrowers, the Innovative Lending Platform Association, a trade organization involving some of the best-known players in the alternative lending arena, has devised what it calls a SMART Box, which attempts to clarify graphically the total cost of a business loan, similar to the clarification provided by the APR disclosure found on credit card offers.
The Banking Alternative
The major appeal of alternative lenders is that they offer credit to businesses that typically cannot get funds from traditional banking institutions because they lack sufficient credit history or do not meet the financial requirements. Nonetheless, Geraci says, there are no substitutes for a strong relationship with a full-service bank offering checking, treasury services, online/mobile banking, credit cards, and more.
“Any single transaction is just a piece of the puzzle,” he says. “When you work with a business banker, you’re not just given a single alternative. We can work with customers to create a multipronged solution to maximizing cashflow at minimum expense. You’re dealing with a human who is committed to understanding your business and helping it succeed, not a computer algorithm.”
Banks, too, are learning lessons from the fintech revolution. “We’re better at identifying credit opportunities for our customers, and we’re leveraging automation to speed up the application and approval processes,” Geraci points out.
To that end, PNC has added an online application for business loans and, in the first half of 2017, reduced the time from application to funding small business loans by 55%. In addition, he says, banks are partnering with fintech lenders to expand their lending product line.
“It’s not necessarily an either-or situation,” he says. “We can work together to provide our customers innovative funding solutions while building on our deep experience with managing risk.” Regulators, he adds, are showing interest in supporting “responsible innovation,” as with the Office of the Controller of the Currency’s recently established Office of Innovation.
Ultimately, the decision about whether one of the alternative lending products is right for your business depends on multiple factors, especially how well the loan matches your need and your projected ability to repay without threatening your company’s cash flow. Regardless, having alternatives can be good for your business. Yet there are indications that women entrepreneurs are not taking advantage of these new sources of funding. In fact, Fundera reports that just one in four applicants is a woman.
Chatham University’s Center for Women’s Entrepreneurship encourages its clients to spend time examining the alternatives before the need for credit arises. “There is no such thing as free money,” Harris says. “Educating yourself is crucial.”