Small business funding has changed. Small business lending fell by over 50 percent following the financial crises of 2008 as tighter regulations and stricter capital controls forced banks to reduce lending.
Given the low returns and high administrative costs of due diligence and credit risk assessments smaller loans simply stopped being cost-effective for traditional banks.
There are, however, more than 5.4 million small businesses in the UK alone, and this shift presented a huge opportunity for non-bank lenders who could offer, as Rohit Arora, cofounder of Biz2Credit says, ‘faster approvals, greater competition for qualified borrowers, and better rates and terms for small business owners.’
Who needs banks anyway?
It makes little sense to go through the time and labour-intensive process of applying to a traditional bank when there are many alternative sources of small business funding dedicated to providing fast, efficient, flexible financial services online.
Small business lending is the Wild West for smart young things using technology, data and their own bright ideas to ‘uberize’ small-business banking services. This has led to aggressive growth in the financial technology, or ‘fintechs’ industry.
Fintechs offer app-based services to small businesses and startups wanting to ‘streamline processes and make their companies more efficient in the 21st century’. Their success is based on their ability to collect vast amounts of data from their users.
They combine company accounts, bank statements, cash flow statements and tax records with credit histories as well as social media accounts and online reviews to generate a comprehensive credit risk profile of your business. This lets fintechs take a more ‘balanced and fair’ view of your creditworthiness as a small business.
Sophisticated algorithms, complex technology and easy-to-use platforms subsequently make credit checks accessible at a click and a swipe; and your loan application easier, cheaper and faster.
Depending on your business model, there are three types of fintechs you can approach: crowdfunders, peer-to-peer lenders, or balance sheet finance providers. Let’s take a look at each.
The power of crowds
You can share your bright idea on a dedicated crowdfunding platform such as Kickstarter, Indiegogo or Quirky. Interested ‘funders’ contribute in return for company products, experiences or just goodwill.
Crowdfunding is not risk free though. You are open to a very public reckoning if your company or product fails to deliver. When you share product details and content online you risk ‘plagiarism and idea theft’. Scams and mismanagement of funds are also possible since the law has yet to catch up with technology in this arena.
Trusting your peers
They use online loan application processes to determine and price your credit risk and then connect you to investors who match your risk profile. The investors or lenders pay a fixed fee for this service. Lenders receive better rates than they would in a savings account while borrowers receive funds at competitive rates.
P2P lenders now consist mostly of institutional investors, venture capitalists and hedge fund managers. P2Ps provided 92 percent of all alternative financing in the UK in 2014.
Choosing balance sheet lenders
‘Online balance sheet lenders’ such as Liberis, iwoca, OnDeck and Kabbage also offer small business loans. They are not intermediaries though and lend their own capital – which may well have been raised from the same types of investors who lend via P2P platforms. These tend to charge higher interest rates but can provide short-term financing quickly and efficiently online.
The small print of alternative small business funding
Comparison portals such as Biz2Credit provide a reasonably transparent platform for the comparison of services provided by various P2P’s and other alternative lenders but since most fintech services are neither regulated nor transparent you must consider the various types of financing available against your longer-term prospects before committing.
If interest rates rise or investors lose interest in providing additional capital to fintechs, your business could be at risk if you are unable to raise the funds to pay off loans or finance growth.
High or variable interest rates, fees for multiple loans and additional charges can also raise costs significantly. So while small business funding might be easier to acquire thanks to modern technology, it doesn’t remove the need for careful planning on your part or the risks of small print.