THE ADVANTAGES AND DISADVANTAGES OF ALTERNATIVE LENDING
By Brittney K. Suttle, CPA
Flashback to 2007: Your small business needs financing, either because your company is growing too fast or because your customers aren’t paying you fast enough. Either way, your funds are drying up and you feel a desperation for cash that is almost palpable. You think that you can scrape by for a few months, hoping to build the credit or backing needed to support a bank loan, but then something like the Great Recession of 2008 hits.
Suddenly, you are officially up a creek without a paddle.
It’s times like these when another financing option can come to the rescue. It’s called “alternative lending”.
Prior to 2008, banks were already tightening their belts. After the Great Recession made its dramatic entrance, though, it was nearly impossible for small businesses to find any funding through traditional banks.
In 2006, for example, the 10 largest banks in the country lent nearly $72.5 billion to small businesses. But by 2014 that amount had dwindled to roughly $45 billion. That’s a 38% nosedive. On top of that, in October 2012, loan approval rates hit a record low of a mere 14.2% of applications. More than 85% were turned down!
But it wasn’t just the large banks denying loans. Within a 7-year period from 2008 to 2015, lending from all banks dropped by $100 billion from $700 Billion to $600 Billion. That’s a 14.3% drop! Larger corporations were the ones typically getting the loans that were made. What’s a small company supposed to do?
While alternative lending was around well before the Great Recession, 2008 was the year that new financing alternatives became critical, jumping to the forefront of small business financing. The demand for alternative non-bank funding sources is still in great demand today, five years later.
WHAT IS ALTERNATIVE FINANCING?
Alternative financing is a term for the range of lending options available to business owners outside of the traditional banking sphere. Many times, documents are exchanged entirely online on a peer-to-peer (P2P) basis.
Typically, there is more flexibility with these types of loans. For example, borrowers may be able to use real estate or outstanding invoices as collateral, making approvals easier.
In addition, because many of these alternative lenders don’t have as much red tape in their review process, they are able to respond faster with a wider variety of funding options and more attractive terms than a traditional bank lender.
WHO IS ALTERNATIVE LENDING FOR?
Alternative lending is a great option for small businesses who meet one or more of the following criteria:
» Inability to qualify for traditional bank loans. Because of the flexibility of alternative lending, small businesses that don’t meet the qualifications of traditional banks will often be able to qualify for this type of lending.
» Need cash quickly. Most alternative lenders are not banking institutions. This means that a) there is less government oversight and b) they don’t have to process as much paperwork. Less regulations + less paperwork = less time required to approve and finance a new loan.
» Small loan value. Big banks typically won’t lend out less than $250K, so if your business requires a smaller amount (i.e. for equipment financing, low-dollar line of credit, etc.), alternative lending can fill that smaller need.
ADVANTAGES OF ALTERNATIVE LENDING
Alternative lending has some distinct advantages for small business owners. The benefits include:
1. SPEED – While traditional banks use money from checking and savings accounts to fund their loans, alternative lending platforms get funds from accredited investors, private equity groups and hedge funds etc. With no depositors and less accountability to sophisticated funding sources, the government puts less regulation on them. This means that small and growing companies can get their money much quicker; a significant bonus for cash-strapped companies. In fact, in some cases borrowers can complete their loan applications within an hour (vs. the average 25 hours for a traditional bank loan) and they can receive their money within days (vs. weeks at a big bank).
2. FLEXIBILITY – Because of the reduced regulation, alternative lenders also are able to be more creative in their loan approvals, repayment terms, collateral types, and loan amounts. In addition, the types of loan offerings are vast, ranging from crowdfunding to sale-leaseback programs to various types of government guaranteed SBA loans.
3. ACCESSIBILITY – Small, growing businesses run at a fast pace. As a result, removing barriers that make operations less efficient is a big win for these companies. With alternative lending, these borrowers can typically skip multiple trips to the bank by submitting their loan applications directly on-line. They never have to leave their desks. Many applications can be completed in under an hour, which means one productive lunch break could keep your business moving forward.
DISADVANTAGES OF ALTERNATIVE LENDING
Unfortunately, it’s not all sunshine and rainbows when it comes to alternative lending. There are Pros and Cons. Here are a few of the Cons to consider.
1. MORE EXPENSIVE – Because alternative lending is used by small often unproven businesses, they represent a greater risk. As a result, non-bank-lenders typically require a larger reward that comes in the form of higher interest rates or a shorter term. This additional interest income helps them to cover their losses on the riskier loans that default.
2. SMALLER LOAN AMOUNTS – Alternative lending platforms also mitigate their risk by offering smaller face amounts. The vast majority of these loans range from $1,000 – $50,000, with the most common loan in 2017 averaging $13,000. However, they can go much higher, depending on the financing type and credit rating of the borrower.
3. SHORTER TERMS – A third way risk is mitigated for alternative lenders is by shortening the repayment period. This means small businesses may end up having access to funds for a shorter period of time, which may put pressure on their cash flow once the loan expires. However, most businesses may be able to extend the term if they have remained current on the prior loan and maintain a solid credit rating.
4. MORE FREQUENT REPAYMENTS – While traditional bank loans typically require monthly payments, some alternative lending solutions require daily or weekly repayments. This is especially true for collateral that is backed by credit-card receivables. This means that borrowers will need to have a strong understanding of their weekly cash flow needs to ensure that they can meet their repayment obligations on a timely basis.
WHAT ARE YOUR OPTIONS?
Here at Commenda, alternative lending is one of the financing tools that we use to help our clients raise the capital they need to support and grow their businesses.
If you’re interested in scheduling time to see how we can help you get the funding that you need to grow, please click-on the contact us page on this website and send us your contact information along with a brief summary of your needs. We’re anxious to learn more about your opportunity, so we’ll get back to you promptly.