Finding finance in any economic climate can be challenging, whether you’re looking for startup funds, capital to expand or money to overcome financial hurdles. Given the current state of affairs, securing funds is as tough as ever. A keen topic of discussion is if customary bank loans are the best option? Customary bank loans were once seen as the only viable source of funding, but as lending criteria have become more stringent than ever before, many businesses have had no choice but to explore alternative funding routes. Thanks to continuous innovation in the financial technology space, entrepreneurs now have more options when it comes to accessing vital capital that could help catapult their venture to the next level. The new options available to those businesses who don’t make bank’s strict standards, come in the form of P2P, Crowd funding, and Alternative Lenders. The rise in new kinds of lenders gives startup businesses options they’ve never had before and promises a new era in entrepreneur business financing.
Banks: The Only Solution?
It is well known that for some time banks have reined in the finance available to small and medium-sized businesses by narrowing their lending criteria. It is not solely because businesses aren’t creditworthy, many are turned away by banks because they do not fit the bank’s “lending model”. Banks are taking fewer risks, so only lending to more predictable, conservative investments and small business owners. Banks would rather back larger loans because it’s more profitable for them, whereas most small businesses seek loans of less than $100,000 according to the Harvard Business School working paper by Karen Mills. It costs a bank the same amount to process a $50,000 loan as it does a $1 million loan, but obviously it can make more money by underwriting the latter.
If we take a closer look at the stats for banking giants’ lending to startups and looking at how many small businesses are rejected because of strict lending standards, the above observation is rather apparent. Compared to a decade ago, the biggest banks in the US are offering far fewer loans to small businesses, thus ceding market share to the alternative lender. For example for all the small businesses that applied for financing in the first half of 2016 only half of them received any amount, according to a survey by the Federal Reserve Banks of New York, Atlanta, Cleveland and Philadelphia. According to figures from Commercial Banks in the United States, there has been a reduction in loan distribution across both “Loans in bank credit” and “Commercial and industrial loans”. The percentage changes are as follows; from 8.1% for 2016 Quarter 1, to -1.0% for March 2017 for Loans in bank credit , and for Commercial and industrial loans it decreased from 8.3% to -8.3% for the same period. As stated by the Federal Reserve System, credit lending to companies (industrial and commercial) decreased at an annualized 3 percent in December, the steepest monthly fall since 2010.
A small business loan application can be rejected for the following reasons: business credit scores are bad or non existent, a lack of collateral e.g. physical property to guarantee the loan or the business has a limited cash flow that cannot cover monthly loan payments. The biggest obstacle is how risk averse banks are post-financial crash since 2008. Banks not only expect to see impeccable credit and detailed financial data but also two or more years in business, which tends to mean an automatic “no” for new startups. Nonetheless, businesses shouldn’t be deterred because thanks to innovation in technology there are other routes available for aspiring entrepreneurs.
The Truth Behind Peer-to-Peer
Peer-to-Peer lending is a new method of financing that allows people to borrow and lend money without a financial institution. The popularity for this type of lending has grown rapidly in recent years and is a great new source of fixed income for investors. The marketplace of P2P lending works through an online platform, which connects borrowers to lenders, thereby cutting out the traditional banking protocols. The P2P platforms do not lend their own funds but act as facilitators to both the loan-seeker and the loan-giver. The peer-to-peer lending industry has become a viable alternative to standard bank loans and is fast emerging as a major competitor to the traditional banking system. With interest rates at an all-time low since 2008 and many traditionally “safe” investments like government bonds carrying negative yields, businesses borrowing from P2P lenders in 2017 could be seen as a no-brainer. However, we must ask if they really do provide growing businesses a better deal?
The biggest selling point for this type of finance is that by harnessing technology and big data, P2P platforms connect borrowers to investors quicker and cheaper than any bank. Furthermore, in comparison to stock markets, P2P investments are less volatile, and can offer higher returns than conventional sources. The benefit for borrowers is the easy access to loans at decent or higher rates, small loans for specialized purposes, and passion for small business ambitions. David Galland from Garret/Galland Research has noted : “The industry is making serious inroads into the Small and Medium-Sized Enterprises (SME) space and their share is expected to grow to 16% by 2020. The bankers are now paying very close attention to the rising competition.” Although peer-to-peer lending has many advantages for startups including flexible loan terms and more relaxed credit requirements, there are still some key drawbacks. Because P2P platforms are still very new, there is limited legislation in place to protect businesses against lending risk – currently any money acquired through this channel won’t be covered by the Financial Services Compensation Scheme (FSCS). Secondly, many peer-to-peer schemes require you to lock up your funds for at least a year which means any cash you do have could be tied up. If you want to access your cash before the loan ends, there may be charges to pay or you may lose out on some interest.
Beyond Banks, P2P and Crowdfunding
Alternative lenders are revolutionizing startup financing, so the range of options are broader than they’ve ever been.The U.S. currently draws the largest amount of fintech investment and is home to many early success stories; with fintech companies generating approximately $8.15 billion in revenue globally in 2015. With so many fintech firms entering and disrupting the market, entrepreneurs that were previously unable to secure capital are finally able to get off their venture the ground. As the hurdles have become less challenging, there has been a surge in small business optimism according to a new survey by USA Today – over 60% of business owners said accessing funds was not difficult and there had been a 6% increase in the number of entrepreneurs opting for an alternative lender since 2015. This shift in market share in business financing is shaking up the industry so much so that even banks are starting to pay attention to alternative lenders and entering partnerships with them. Unlike customary bank loans and some peer-to-peer platforms, alternative lenders offer more diverse financing options including cash advances, and the best part is that when they assess a company, approvals are based on a business’s overall health not just a credit score meaning more opportunities for fledgling startups than ever before. SFS Capital is one of the many non-traditional lenders offering flexible cash solutions and payment terms, whilst RapidAdvance alone has provided over $1 billion in financing to small businesses nationwide, helping them grow and positively impact the communities they serve.
Rachel Thompson is a researcher for Expert Market, a leading B2B marketplace. Her writing interests are diversity in business and the impact start-ups are having for millennials in the marketplace.