No Longer Are Traditional Banks The Only Option For Small Businesses

Banks are the principal source of outside capital for small businesses, but there have always been alternative forms of loan capital available, including credit unions, Community Development Financial Institutions (CDFIs), merchant cash advances, equipment leasing and factoring products.

Historically, this segment of the market has been small compared to the $700 billion in small business bank credit assets. But since the onset of the financial crisis, and particularly during the economic recovery, there has been significant growth in innovative, online alternative funding for small businesses. The outstanding portfolio balance of online lenders has grown about 175 percent a year, compared to a decline of about 3 percent in the traditional banking sector. However, it still only represents less than $10 billion in outstanding loan capital.

Despite their small scale, these alternative players have the potential to fundamentally change the way in which small businesses access capital , creating greater competition, price transparency, and a better customer experience. Emerging online players are pushing innovation within the lending sector in the same ways in which other online upstarts such as Amazon.com changed retail and Square changed the small business payments business.

A few factors account for the rapid growth of the entrants. First, institutional debt and equity investors have been attracted by the relatively high rate of returns available by lending in this market. Traditional bank loans may yield a return of 5 to 7 percent, but many alternative lending platforms charge yields ranging from 30 to 120 percent of the loan value, depending on the size, term duration, and risk profile of the loan.

The growth is also driven by ways in which alternative lenders are innovating in small business lending, particularly in terms of simplicity and convenience of the application process and speed of delivery of capital. For example, all of the biggest players emerging in the alternative lending space offer online and mobile applications, many of which can be completed in under 30 minutes.

These are not just inquiries; these are actual loan agreements.

This compares to the average of about 25 hours that small businesses spend on filling out paperwork at an average of three conventional banks before securing some form of credit, according to the Federal Reserve Bank of New York’s Fall 2013 Small Business Credit Survey. Upon filling out an online application, owners can be approved in hours and have the money in their account in just days, whereas in the conventional banking model small business owners may not be approved for several weeks.