Alternative lending solutions are cropping up as the answer for small business owner’s battling the tight credit market. Banks continue to be tight fisted with loans, and owners face lengthy approval waiting periods—something that most small businesses can’t afford. In response, a new breed of lenders are hitting the market that rely on small business’ cash flow and payment history rather than just credit scores. These lenders say they're willing to take a risk on these companies and give them swifter, simpler access to cash within days.
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Noah Breslow, COO of On Deck Capital, an alternative lending company for small businesses, said his company is a product of banks' sinking confidence in a post-credit crisis world.
"Nine out of ten businesses try to go to a bank first," Breslow said. "They have this idea that they should walk into a local bank branch because it’s the fastest and most effective way. Banks are diverting their attention away, trying to fix other things in their business, and they’re not focused on growing their small business lending portfolio."
According to Breslow, the online lending service has loaned out $200 million over four and a half years to more than 6,000 businesses. Breslow said the average loan is around $30,000 and can be accessed in no more than seven days. The interest rates on loans are high-- 18% to 36%--but Breslow said the loan terms are shorter, with payment periods from three to 18 months. The company also tells business owners what their lending options are based on their ability to pay including Small Business Administration and bank loans in the mix.
"If you are a retailer buying inventory for the spring season, and will sell it in a few months, we are a good fit," he said.
Glenn Goldman, CEO of Capital Access Network (CAN) said his company can weed good candidates from the bad.
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"FICO looks at somebody's score and says, 'We believe they have either a high or low ability to repay this loan,'" Goldman said. "We look at the behavioral analysis of these small businesses and say, 'Based on our understanding of your business, it will look like this and grow and thrive.' If you look like your business is declining, we can't do business with you."
CAN provides working capital and loans to small businesses through its proprietary "risk-scoring models" which assess social and behavior profiles, historical merchant demographics and other data, within 48 hours. The company recently announced a $30 million investment from Accel Partners to retool its online merchant platform, which will debut in April.
The company has lent out $2.4 billion in 10 years to 40,000 customers, Goldman said. The repayment process is done through a daily remittance, which takes out different percentages of daily sales, allowing the business to ebb and flow with the seasons. He declined to give the percentages deducted and said each loan or advance is different, as is the repayment process.
"Rather than asking for a big check each month, a small percentage of their sales are directed to us until we receive the $25,000 loan back," he said. "Daily remittance is product and price agnostic. We have some at a 6% interest rate or some at a 20% or 25% rate."
Goldman said banks rely too heavily on credit scores, and said they miss out on the opportunity to help promising companies. Goldman said 75% of eligible customers come back for multiple loans and advances.
"We turn down people with FICO scores of 800 and say yes to people that have 400 FICO scores.”
For e-commerce entrepreneurs, Kabbage.com provides approved merchants cash advances right into their PayPal accounts. The Atlanta-based company’s CEO, Rob Frohwein, said traditional bank loans often take too much time, and many of his clients are looking for faster cash in small amounts.
Banks are relying on antiquated technology to evaluate businesses that are moving too quickly, Frohwein said. When a small business owner applies for a cash advance, Kabbage.com evaluates its marketplace activity at online marketplaces sites like eBay (EBAY) and Etsy, as well as their PayPal account. Within minutes, the site will present businesses with an offer and with interest rates ranging from 2% to 18% for up to six months to repay, and the cash is taken straight from the business' PayPal account.
In the past six months, the company has put out more than $10 million to more than 15,000 businesses and is growing by 35% month-over-month, he said.
"The goal here is not to cut off what might be a lifeline of money, because a business needs cash to grow," he said. "But we make sure we understand the nature of how they are using the cash. We track the cash to see if the business is down or flat, and there may be a 'No' for providing future cash."
Looking Before You Leap
Like with any loan, Ray Keating, chief economist for the Small Business & Entrepreneurship Council, said the burden to assess risk falls on the business itself. Owners should acknowledge what is at stake if he or she fails to repay or properly use the loan.
"Even in the best of times, it's difficult to walk into a bank as a startup and get a loan," Keating said. "The more options out there for firms, the better it is."
Gretchen Maser, 51, has owned her business, Christina Maser, for the past 12 years. Her soy candles, soaps, jams and jellies are sold in WholeFoods (WFMI), West Elm and were even included in SAG Awards swag bags this year.
Maser has a line of credit with Graystone Bank in Lancaster, Pa. The kind of growth her business has seen can either make or break a small company, depending on access to capital, she said.
"It’s the kind of account that rocks your world. If I had to, I would try all [lending] options. Compared to the alternative of 'Maybe this business doesn't happen.'"
At the moment, she would steer clear of alternative lending, she said.
"I don't know that I am that big of a risk taker," Maser said. "The whole world of money is changing—it’s not simple math anymore."
If $25,000 in seven minutes sounds too good to be true, Kabbage.com’s Frohwein said there is the same amount of risk at stake for his company when lending to smaller, newer businesses.
"It doesn't help us when one of our customers gets into trouble," he said."It doesn't benefit anyone when businesses get into trouble."
Keating said the lender is putting a lot at stake in approving loans, but smart choices on both sides of the spectrum will help to weed out those who don't make the cut.
"If the lender doesn't do their vetting process properly, they will go under, and if the business [doesn't borrow properly] it will go under. The market does work."