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Demystifying Alternative Lending: Series 3 of 3

For the final article of the “Demystifying Alternative Lending” series, we will answer the vital question: Is alternative lending right for your business?

Small businesses struggle to get loans from traditional lenders such as Wells Fargo and Bank of America. Only about 30-40% of small businesses are approved for a loan from large traditional banks. Furthermore, larger banks have been moving away from lending below $150,000 due to high costs to service loans and low collateral value of small businesses. In addition, small business owners find the traditional loan process difficult due to high credit standards, significant paperwork and slow turnaround time (2-3 months). A banker at a traditional bank mentioned he targets prospective borrowers with a capital need of at least $150,000 with a personal credit score of at least 680.

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 three business days. 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. For more info on process, read the first article of this series. The largest concern about these alternative lending options is the high annualized interest rates ranging from 8% to 60%+. At these pricing levels, these loans may be cost prohibitive to small businesses, especially when compared to SBA loans that are priced between 6 and 8%. Hence, alternative small business funding may not work for everyone.

However, alternative small business funding does work for many small businesses. In fact, nonbank lenders loaned about $9 billion in 2015 (source: Liberum). 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 or informal (hard) lenders with interest rates much higher than alternative capital 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. In summary, the opportunity costs of not getting an alternative loan could outweigh the cost premium for an alternative loan.

Alternative lenders provide various lending options to cater to the different needs of the business owner (read second article of series). 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.