Online Lenders: New Hope for Cash-Strapped Entrepreneurs
A couple of weeks ago, I posted an articlethat described how much tougher it is for entrepreneurs to get a loan. The evidence is clear: a Harvard Business School (HBS) working paper (PDF) said that small business loans as a share of total bank loans has dropped from about 50 percent in 1995 to 30 percent in 2012.
Fortunately, there are alternatives. Credit unions and Community Development Financial Institutions (CDFIs) have long specialized in serving small businesses. And now another relatively new and growing source of loan capital for entrepreneurs is emerging: online lenders.
According to the HBS report, the outstanding portfolio balance of online lenders is doubling every year compared to a decline of about 3 percent at traditional banks. While the online small business loan market is still small (less than $10 billion compared to nearly $700 billion for banks), it’s becoming big enough that even banks are eyeing opportunities to get in on the online action.
Is it easier to get a small business loan online?
The HBS research suggests online lenders are more likely to take on risk in small business lending and to open new pools of capital for entrepreneurs. But the growth in online lending seems equally driven by innovation. According to the HBS report, online lenders provide:
• Convenient, easy-to-use applications, many of which can be completed in less than 30 minutes;
• Quicker loan approvals, often within hours, and money deposited to the account within days; and
• A greater focus on customer service.
Many online lenders are also developing data‐driven algorithms to more accurately screen creditworthy borrowers.
Confidence in alternative online credit sources is growing. At the same time, because it is so new, online lending is raising questions and concerns, particularly around regulation, that continue to evolve.
So who are these online players?
The HBS working paper points to three types of online lenders for small business. They are:
1. Online balance sheet lenders
Companies like OnDeck and Kabbage use their own balance sheet capital to underwrite loans to small business. They raise capital from institutional investors, including hedge funds, and use proprietary risk-scoring models that include non‐traditional data to decide on loans for entrepreneurs. Loans are typically short‐term (less than 9 months) to fund working capital and inventory purchases.
2. Peer‐to‐peer (P2P) platforms
These include Lending Club, Prosper, Funding Circle and Fundation. Large retail and institutional investors such as hedge funds and investment banks direct capital to P2P marketplaces. The P2Ps use a proprietary credit model to decide on loans to prime and super-prime quality borrowers, including small businesses.
3. Lender-agnostic marketplaces
Lendio, Fundera and Biz2Credit provide online marketplaces that connect borrowers with a range of traditional and alternative lenders, including banks and new credit sources. This enables small business borrowers to comparison-shop from a wide range of loan products and funding sources. Intuit is also introducing a lending platform for its small business customers who use QuickBooks Online (QBO). Customers can use their cloud-based QBO data to create a predictive credit score and then use their score to apply for loans from providers like Wells Fargo and On Deck.
What do you think?
Have you used an online lender? Do you plan to? I’d love to read your comments and any experiences you’d like to share.
Originally published October 29, 2014