Small businesses struggle to get loans from traditional lenders. In 2014, the approval rate for small business applications at national banks was approximately 31%, according to the Federal Reserve. As a result, there is an estimated unmet need of $70 to 120 billion The main impediments of the traditional small business loan process are and will continue to be the same in the unforeseen future. First, the traditional lending process takes too long. A typical SBA loan, a loan partially guaranteed by the government-backed Small Business Administration, takes 2-3 months to process. Second, small business owners do not have the time and resources to collect the required paperwork to process a loan application. Lastly, the personal credit score threshold for qualifying small business loans is too high, irrespective of the cash flows of the business. Recently, a business associate at a traditional bank mentioned he targets prospective borrowers with a personal credit score of over 700, and does not consider applications with scores below 640.
Over the past 10 years, alternative lenders have emerged with a value proposition that directly addresses these pain points. Alternative lenders use a formulaic approach to pre-qualify loans within minutes and fund as soon as 1 business day. Throughout the loan approval process, paperwork is kept to a minimum and cash flows are taken into stronger consideration relative to a business owner’s personal credit score. The largest concern about these alternative lending options: these loans are expensive with annualized interest rates from 8% to 55%+. At these pricing levels, these loans may be cost prohibitive to small businesses, especially when considering an SBA loan is typically priced between 5 and 6%. Hence, alternative small business funding may not work for everyone.
However, alternative small business funding does work for many other small businesses. In fact, a BusinessWeek article cited that nonbank lenders loaned about $3 billion in 2013. The reality is: the pain points of the traditional lending process are real. At Camino Financial, we come across many businesses that have working capital constraints with cash locked into the business, impeding investments in growth and/or maintenance. Even worse, most of these small businesses resort to their credit cards with interest rates much higher than some alternative small business funding options. We also find many businesses with sound cash flows, but business owners have low credit scores for many reasonable reasons (e.g., short-selling home during the mortgage crisis). Or, we find proven businesses that need immediate capital to purchase a large order of inventory to stock for pent-up demand. The examples are endless and the needs vary in nature.
Alternative lenders provide various lending options to cater to the different needs of the business owner. For ongoing working capital concerns, an open line of credit can offer a small business owner a cheaper credit alternative to a corporate credit card. For equipment purchases or business expansion, a short to medium term loan can increase productivity and revenue for a small business, providing a rich return on investment within the term life of the loan. And for the seasonal business that needs immediate capital to purchase inventory, a merchant cash advance could provide immediate access to capital with reasonable flexibility to pay back the funds within the seasonal constraints of the business. So before you dismiss alternative small business funding due to their high-perceived cost, consider the relative value your business can derive from alternative capital, without the typical pains and obstacles.