Come time for a business loan, whom do you turn to? Most likely the corner banker who holds your checking account. That person knows your enterprise best and has a vested interest in its success.
Even the friendliest local banker, though, might respond to a loan request with a resounding “no.” Reason? The regulatory environment: The nation’s financial meltdown a decade ago sparked a network of tighter lending rules that still hamper the flow of money.
“Prior to the recession of 2008, conventional lending was booming,” said Parag Nevatia, CEO of EZ Funding Solutions, Metuchen, New Jersey (ezfundingsolutions.com). “If you had six months of business history and receivables, banks would throw you money. Then came the financial crisis and conventional financing froze. Bankers started asking for cash flow, credit score, and collateral. If any one of the three was missing, you were out of luck.”
Getting to yes has been made tougher by the continuing merger of financial institutions, leaving borrowers with fewer choices. “Bigger banks have been swallowing community banks and gravitating toward the business of making larger loans,” states a recent story in The Wall Street Journal. The problem’s worse if you are in one of a growing number of small towns and rural communities where banks are closing profit-challenged branches.
Shut out of the money market, you might turn next to a loan sponsored by the Small Business Administration. But those can be just as elusive. “An SBA loan is not a slam dunk,” said Denise Beeson, a business consultant based in Santa Rosa, California. (denisebeeson.com). She points out that the lenders involved in such arrangements look just as closely at an applicant’s credit and financial records.
Enter the nonbanks
So what to do? One fairly new resource is an array of alternative, nonbank lenders. These online operations include such entities as Lending Club, Prosper, Funding Circle, Kabbage, OnDeck Capital, Headway Capital, BlueVine, StreetShares, Fundera, Lendio, Noble Funding, and PayPal Loans (Not all platforms are legal in all states).
An additional group of nonbank lenders caters primarily to consumers, but also represents potential money sources for small business owners. In this group are Upstart and Peerform, as well as residential mortgage lenders Quicken Loans and The Money Store. “While you could borrow from consumer-oriented lending platforms, you are likely to get less money,” said Barbara Vrancik, a small business financial consultant based in New York City (BarbaraVrancik.com).“They often just look at your credit score and income when reaching a loan decision. In contrast, business lenders may take into consideration your total business revenues and the number of years you have been in business.”
Some alternative lenders operate as Peer-to-Peer (P2P) platforms, web-based intermediaries matching borrowers with pools of relatively small investors. Others act more like brokers, matching loan applicants with a curated group of larger direct lenders. Whatever their internal dynamics, such organizations can toss lifelines when the need for money butts up against a conservative lending environment.
And that lifeline can be especially welcome when a business has an urgent expense. “Nonbank lenders can usually make loan decisions more quickly than commercial banks,” said Marilyn J. Holt, a Seattle-based consultant and author. Some loans can be granted in 24 hours, while others might take only a week or a month—far speedier than the typical waiting period of up to 90 days required by traditional banks. “One reason is that private lenders often do not need to conform to the same federal and state regulations as commercial lenders.”
Nonbank platforms have a number of other advantages. “Alternative lenders are often willing to take more risk in return for higher interest rates,” said Jennifer Rusz, CEO of Sterling Rose Consulting Corp, Lawrenceville, Georgia (sterlingroseconsultingcorp.com). Commercial banks often want to see steady profits over the course of a 12-month period, while nonbank lenders are often more flexible—a special consideration for seasonal businesses. Too, alternative lenders often welcome certain categories of loans—working capital or lines of credit, for example—that a commercial bank might shun.
All these advantages make online platforms attractive. So does another one: expertise. “Often alternative lenders are savvier than commercial banks which often experience great turnover in their lending officers, many of whom can be inexperienced,” said Holt. “Additionally, nonbank lenders sometimes specialize in certain types of loans or in specific industries, and their greater knowledgeable can translate into more flexible lending policies.”
Of course, alternative lenders aren’t without drawbacks—not the least of which is cost. “Fees charged by these platforms are high, often ranging from three to seven percent of the loan,” said Vrancik. When you add those fees to the interest rate charged, she said, the loan can be quite expensive, resulting in an Annual Percentage Rate (APR) of up to 40 percent or more. “The weaker the credit score and the financial condition of the borrower, the higher the cost of funds and the shorter the terms of the loan.”
Funding from nonbank lenders also carries risks that business owners may not fully appreciate, said Vrancik. “One risk arises from the fact that the financial analysis required by nonbank lenders is often not as exacting as that of traditional banks. As a result the financing can end up being a little too easy, and the small business owner can be tempted to take on more debt than is prudent. That can spell trouble for small businesses who are often under very tight cash constraints.”
The bottom line is to have a firm grasp of your ability to meet the mandated repayment schedule. “If you cannot repay your loan quickly, then nonbank lenders will be the bane of your existence,” cautions Holt. “They often move faster to collect their debts than the large, cumbersome banks, and that can ruin your credit. While they sometimes will restructure your loan, that will seldom be to your advantage. Keep in mind that even though they want you to succeed, they have their own private investors to answer to.”
A second risk arises from the distance between you and the nonbank lender. The organization providing the money has no knowledge of how your business operates.
“Without a working relationship with the debt holders, you have limited flexibility in renegotiating terms down the road,” said Vrancik. “In contrast, local bankers will often be motivated to see your business succeed, especially if they anticipate providing you with services in addition to the current loan. For example, you might be able to negotiate an extension of payments or a waiver of a provision for a couple of months until a big contract comes in.”
Finally, bear in mind that nonbank lenders are not subject to many of the same regulations as traditional lenders. That raises questions, said Vrancik, about what they do with your business information. “I would be concerned about offering sensitive information online, or providing a direct link to your bank account, without being familiar with a lending platform’s security provisions.”
As the above comments suggest, a lack of regulation means an absence of standardization in lending practices and limited safeguards for borrowers. “It’s even more important than ever for borrowers to engage in due diligence concerning lenders and their policies,” said Beeson.
Among other things, due diligence means talking with references. “Find out if the lender has been in business a long time and with whom they have done business previously,” said Holt. “Interview their previous and current clients—and makes sure the people provided as references really are their clients.” Avoid vulture lenders, who often charge excessive interest rates and demand quick repayments.
Getting unbiased feedback can be a challenge—all the more so if you rely only on reports from your competitors. “Businesses outside your industry are more likely to share honest insights,” said Holt. “Make yourself an active member of a larger business community.” Network with members of your chamber of commerce or other business improvement group.
Smart borrowers shop around. “Apply to at least five or six lenders, being consistent in what you tell each one,” said Holt. “Do your homework by studying their websites and asking about their expectations. See if they are listed with the Better Business Bureau and find out which ones have had complaints filed with your state’s attorney general.”
The only way to accurately compare loan offers is to compare APRs, making sure that the figures reflect both interest rates and service fees. One thing is virtually certain: Your cost of money will be higher at alternative lenders than at commercial banks. “These platforms are not giving away money,” said Vrancik. “They want to be compensated appropriately for their risk.”
If cash is costly from alternative lenders, sometimes paying a higher rate is the only practical solution to a business problem. “If you need the money and have to bite the bullet, then you do it,” said Vrancik. “But first, do your homework.”
Sidebar: Vetting the Nonbank Lender
Landing a good deal with an alternative lender requires careful planning and vetting. The loan application should convince the lending platform that the borrower can capitalize on the borrowed funds and can meet the repayment schedule.
“Start by identifying what you need the money for, how much you need and for how long,” said Barbara Vrancik, a small business financial consultant based in New York City (BarbaraVrancik.com).
Then go one step further by showing the prospective lender how the borrowed money will result in higher profitability, generating the funds required to repay your loan.
“Have a detailed plan showing how your loan will make at least two times as much money as its total value,” suggests Marilyn J. Holt, a Seattle-based consultant and author. “And have a strong, verifiable plan rooted in reality for how and when you will make your repayments.”
When researching prospective lenders, Vrancik suggests asking these questions:
- What are the interest rates and fees?
- How frequent are repayments, and in what amounts?
- Does the lender require collateral?
- Will the loan restrict your ability to incur additional debt, or to operate your business in any way?
- Can you modify the terms of the loan if you should need a waiver or extension down the road?
Compare the answers from the prospective lenders and go for the best deal.