As the economy continues to show some signs of improvement, the credit market for small businesses steadily evolves. Small banks are approving more than half of business loan applications they receive. While the approval rates for the big banks ($10 billion+ in assets) is much lower than that of small banks, they are granting 17.6% of the requests they receive, the highest rate since the Great Recession began five years ago this month.
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When the credit crunch hit, banks almost completely turned off the spigot for small businesses, money had been pretty much free flowing before that. Then, after the fall of Lehman and the collapse of the real estate market, big banks adhered to strict lending parameters that made it tremendously difficult to secure small business financing -- even if a company had strong balances. The banks asked for three years of financial information, but unfortunately the results in 2009, 2010 and 2011 were often less than robust. Further, startups, by nature, could not provide such extensive information.
As banks stopped funding deals, alternative lenders filled the void for entrepreneurs in need of startup or expansion capital or the funding to cover cash flow issues and other short-term financial needs. Tech-savvy lenders made cash available quickly and efficiently and were willing to grant loans when other institutions would not. These so-called alternative lenders included cash advance companies, accounts receivable financers and factors.
Alternative lenders proved more willing to take risks and more forgiving of low credit scores. They made quick decisions -- sometimes instantaneously. Their integration of technology enabled borrowers to easily upload their financial information. For many small business owners, quick access to cash outweighed lower interest rates.
The funding from alternative lenders came at a premium price, however. Many people still consider them just "one step above a loan shark." While a traditional bank loan can be obtained at interest rates between 5 and 7%, alternative lenders tend to nominally charge 20%.
Cash advance loans may seem attractive to small business owners who want to secure funding in a short amount of time and pay it back in installments that come out of future sales. For instance, a company might borrow $40,000 and then pay back $48,000 in six months' time. This seems like the interest rate is only 20 percent, but it is really 40 percent because the repayment period is half a year. Sometimes the borrowers keep coming back for more and the debt continues to mount. This is a bad scenario for a small business owner.
So what are some alternatives to alternative lenders?
No. 1: Small Business Loans from Traditional Banks -- As the economy continues its recovery, banks both large and small are approving a higher percentage of loan requests and loosening their strict lending parameters. Finding the right bank can save you a lot of money in interest charges.
No. 2: SBA Loans -- As part of its mission to help small companies thrive, the SBA helps businesses refinance high cost debt through a number of its loan programs, including SBA Express loans and the 504 Jobs Act Debt Refinance program enacted in 2011. SBA loans can be used to refinance existing, eligible high cost debt thus enabling small business owners to secure less costly funding.
No. 3: Low Cost Alternative Lenders -- We are starting to see mainstream financial institutions offer merchant cash advance funding at rates as low as 6%. This has helped lower interest rates for many small businesses that need a quick infusion of cash.
Alternative lending represents a relatively small percentage of the small business credit market. As banks have returned and as the SBA has become more involved in helping companies get out from under a mountain of debt, small business owners have more viable options.
With more organizations willing to lend today, entrepreneurs can shop around for better deals, even if they need money quickly. The atmosphere right now is very supportive of small business growth. High interest cash advance companies hinder that growth, and thus their role in the lending space is becoming less valuable.
Rohit Arora is co-founder and CEO of Biz2Credit, an online resource that connects 1.6 million small business owners with 1,200+ lenders, credit rating agencies and service providers such as CPAs and attorneys via its Internet platform. Since 2007, Biz2Credit has secured more than $1 billion in funding for small businesses across the U.S.