The average small business has just 27 days of cash in reserve. One in four have less than 13 days. Even those that are flourishing run into cash shortages that can stymie their growth. The solution is simple: an immediate cash infusion to get the gears turning again. For some businesses, that means a small loan to make the next payroll. Or an equipment loan to fix a critical piece of machinery. But when the clock is running, and a bank loan takes weeks or even months to approve, where’s a small business owner to turn?
According to a study conducted by NDP Analytics, online lending platforms have become one of the main options for small and medium sized businesses (SMBs) to access capital. The study found that between 2015 and 2017, five of the nation’s largest small business online lending platforms facilitated $10 billion in loans, generating $37.7 billion in gross economic output. Yet some policymakers and others from the traditional banking world continue to proclaim that online lending is the Wild Wild West, a lawless land that:
- has no transparency
- is predatory and untrustworthy
- does not have small businesses’ best interests in mind.
But $10 billion in loans speaks to the ubiquity and the importance of online lending. Before you believe the hype about “the dangers” of this type of financing, here are a few things to consider.
A Few Bad Apples Don’t Spoil the Bunch
It is true, there have been some online lending companies in the news that were sued/accused of offering interest rates to borrowers that exceed the legal limit. Does that mean the online lending landscape as a whole is tainted? Does it indicate that all online lenders and fintech companies are up to no good and must be heavily regulated?
Regulation is helpful and necessary, when it works to ensure the financial health and success of small businesses The problem, however, is that oftentimes the kind of regulation proposed leads to confusion instead of clarity for small business owners. Groups such as the Innovative Lending Platform Association (ILPA) push for transparency in pricing disclosures across loan products, and many of the nation’s leading small business lenders have adopted these uniform disclosures. When legislation ignores what’s already working effectively in the industry, it becomes redundant and oftentimes counterproductive.
An example is ILPA’s SMART Box model. This comparison tool allows lenders to provide SMBs with clear and consistent pricing, calculations, and explanations to help them understand and assess the costs of their financing options. When developing the model, ILPA engaged with small business owners to identify the pricing metrics they wanted to see when looking for financing, including the total cost of capital, annual percentage rate, and cents on the dollar. In a 2018 study by the Federal Reserve Banks (focused on the effectiveness of online small business lending), the feedback was clear: the small business owners surveyed overwhelmingly liked “the format and the wealth of information” and the ability to make an “apples-to-apples comparison” of a tool like SMART Box.
Can’t Small Businesses Depend on SBA Loans?
It’s true, not every small business owner is looking for a quick, small-dollar loan. Some have more traditional financing needs that the old banking model fits. Some of the most popular types of funding for small businesses are traditional bank loans and SBA loans.
- Traditional banks: Most traditional banks are loathed to process loans under $100,000 due to their high costs of compliance and underwriting. It doesn’t pay for them in the long run. In particular, if a small business owner or startup lacks a strong credit score or a thick credit file, they likely won’t get approved by a bank. And even if credit is not a hurdle, time might be. Bank loans generally take a few weeks to process from application to funding.
- U.S. Small Business Administration: SMBs that can qualify for SBA loans will likely enjoy favorable terms. But if a business doesn’t have an established track record and/or is part of a high-risk industry, they might be out of luck. If they do qualify, SBA loans can take as little as 30 days or as long as six months to fund. This generally doesn’t work well for businesses that need to maneuver fast.
Yet oftentimes, a few thousand dollars is all a small business needs to get on solid footing. The majority of small business owners report needing just $100,000 or less, and in a timelier fashion than bank and SBA loans can deliver. According to Lendio’s SMB Economic Insights report, in Q2 2019 the average loan size on the platform was just over $16,500, with funds typically delivered in a matter of days.
Online lending marketplaces, with a variety of lenders on tap, are unique in their ability to provide business owners with a full spectrum of financing options: from quick infusions of capital like business credit cards and lines of credit, all the way up to long-term financing and commercial mortgages.
The fact is, small businesses, and therefore, the small business economy, cannot survive without all of these forms of lending.
Online Lending Is Here to Stay
Some finance traditionalists might have forgotten about what happened after the 2008 recession. Banks and credit unions fell from the small business loan market and moved upstream, where it seems they only lent to businesses that didn't need funding for survival.
The online lenders who entered the small business landscape to fill the void took huge risks. From attracting capital to fund loans, to efficiently underwriting businesses, to servicing loans without enormously high default rates, they had to innovate in ways that traditional lenders just couldn’t, and for the most part, still don’t.
Ten years later, established online lenders like OnDeck and Kabbage are living proof that this digital transformation isn’t just a passing fad. The fintech market will continually evolve to serve the diverse needs of its customers. A 2018 report from the Treasury Department recognizes the developments in digitization, data and technology, and increasing credit access for small businesses. It stresses the need for the U.S. financial regulatory framework to evolve to enable innovation and ensure a globally competitive marketplace for financial services.
Furthermore, the NDP study states, “through increased access to capital, small businesses across America are able to grow. As these businesses succeed, so do those around them. As such, American communities across the U.S. have realized positive economic impact from online lending.”
As the research demonstrates, fintech platforms provide viable, safe financing options for millions of business owners in the U.S. And when these businesses have access to capital, they’re a powerful force for economic growth and job creation.