This is a big topic—and admittedly not inherently local. But technology is transforming the lending market in ways that can benefit small businesses—or hurt them if they are not careful. As bank loans have become harder to get, a new breed of online lenders is disrupting the market and expanding the funding options for entrepreneurs. The alternative lenders offer unprecedented speed, ease-of-use and convenience. In some cases you can get your loan approved in less than ten minutes! The online lenders use technology to streamline the process. And instead of just relying on FICO scores or collateral, they look at other data, such as Yelp reviews, sales patterns and realtime cash flow, to assess risk. For that reason, they often make loans (including unsecured loans) where a bank cannot or will not.
Alternative lenders (including Merchant Cash Advance, factors and online lenders) have approval rates of 60% or more, compared to 20% for big banks.
For many small businesses, going online rather than going to the bank is becoming the norm. But business owners must proceed with caution. Online lending, for now, is not regulated like bank lending is. That attracts unsavory players whose obscure terms can mask exorbitant rates—the business version of pay day lending. There are also online lenders trying to give small firms a fair shake. The trick is telling them apart.
Merchant Cash Advance (MCA) providers have been around for decades. These lenders are actually credit card payment processors. They advance cash to small businesses and, because they handle payments, take a percentage of sales every day until the loan, plus a premium, is paid back. The advances are typically short term and expensive—and because fees are not expressed as APRs (annual percentage rates) it can be difficult to pinpoint the true cost of that capital. You can easily end up paying the equivalent of 60% annual interest—or much more!
Cash advances can be a lifeline for small businesses that urgently need to pay for things like inventory, which will result in more sales. But many MCA borrowers have become trapped in a cycle of debt, taking out new loans to cover that payments on the existing loans. And there are often fees and penalties that borrowers may not be aware of until it’s too late. So with MCAs, it is caveat emptor!
Asset-backed lenders and factors also have a long history. These firms buy your receivables or invoices at a discount, so you get cash up front rather than waiting 30, 60 or 90 days for payment. But the discounts can be steep. Bluevine and Fundbox are newer entrants to the field that promise transparent pricing and fees.
Cashflow lenders, such as OnDeck and Kabbage, provide short-term, high-interest loans similar to MCAs. But instead of controlling your credit card payments, as MCAs do, cashflow lenders require direct access to your business bank account or, alternatively, your payments systems (ie. PayPal, Amazon, eBay, Square, QuickenBooks, Sage).
The typical loan uses are for purchasing inventory, bridging receivables gaps, expansion, or managing unexpected expenses and cash flow. These lenders don’t obsess over your credit score, they’re more concerned with your cash flow. Because they have a real time window into a company’s sales, they can lend to businesses that other might turn away.
Like MCAs, these online lenders deduct a fixed amount or percent of sales on a daily basis, rather than citing an APR. That can make it hard to tally up the true cost of the loan. They can be less expensive than a MCA—but often not by much.
For example, Kabbage provides loans and lines of credit for 6-month periods. It charges 1% – 13.5% of the loan amount daily the first 2 months, and 1% for each of the remaining 4 months. (There are no penalties for paying back early). There’s also a loan origination fee.
The two firms have been hugely successful. OnDeck has made more than $2 billion in loans since 2007, and has attracted equity investments from Google Ventures, among others.
Payment lenders: In recent years, online payment services have gotten into the act as well. Companies like Amazon, PayPal, Square and American Express already handle merchant payments—and have access to rich transaction data—so it was a logical step into providing working capital.
Online term-loan lenders, for lack of a better term, are the latest entrants to the online lending market. You might call them the white hats, because they strive for more transparent pricing and generally offer small businesses a fair deal. They offer multiyear loans with defined annual interest rates, akin to a bank loan, but with the speed and convenience of online lending.
The capital they lend may come from multiple individuals and institutions (in the case of peer-to-peer or “marketplace” lenders), or it may come from their own balance sheet (so-called balance sheet lenders). Balance sheet lenders have a measure of skin in the game, but other than that there is little difference to the borrower. The rates offered by these online term-loan lenders can range from 7% to 30%— higher than a bank’s rates, but typically lower than those charged by MCAs and other short term lenders.
- Speed and convenience
- There is an online loan product for almost every business need
- Unlike bank loans, many online loans require no collateral
- Short-term loans, even at a high interest rate, can sometimes mean the difference between fulfilling an order or stocking up having inventory for the holidays, or sitting it out
- Online lenders are beginning to offer longer terms loans with clearly defined rates that are more akin to bank loans
- You’ll still need a decent credit score to get a loan or advance
- Caveat emptor: even savvy business owners have beed duped into paying exorbitant fees
- Many online lenders charge origination fees; banks never do
- Some online borrowers have become trapped in a vicious cycle, where they need to take out new loans to pay off the existing ones
- Beware hidden fees, for example, for repaying a loan early
Tip: Do your homework. Read the fine print. Then read it again. Use one of the online calculators to figure out how much you’re really paying, such as this one by Fundastic.
A number of web sites take the legwork out of finding the right lender by allowing borrowers to fill out one online application, and then they match you with suitable lenders. These include Biz2Credit, Fundastic, Fundera, Fundwell and Lendio. Bonus: they all provide good educational tools and calculators on their sites!