If you have recently gone to a bank and were unable to secure a loan, don’t be discouraged. It’s not you, it’s the banks. Bank lending to small businesses is at an all-time low, with around 82% of small business loan applications being denied.
But why is this happening?
While every bank probably has its own set of reasons, the two most popular are:
- Increased Regulation
- Less Potential for Profit
Increased Regulation
Post-recession, banks have been carrying less risk in their portfolios. As they are making loans with consumer dollars, it’s important they adhere to this regulation. Unfortunately, small businesses are inherently riskier than larger businesses. Therefore, there’s less room for small businesses in a bank’s portfolio.
Less Potential For Profit
When it comes down to it, small business owners aren’t often looking for large amounts of working capital. When they need a loan, more often than not, they just need a small amount to get through a tough time or major growth period. For example, Fundera’s average loan size is around $40,000 dollars. However, it costs banks just as much to underwrite a large loan as it does a small one. In order to turn a profit, they are mostly interested in doing 6 figure (and higher) loans.
Understanding what is happening in the bank lending landscape, what is a small business owner to do if they need capital?
Alternative Lending 101
Enter “alternative” lending. With the void in bank lending, alternative lenders have popped up to help business owners get the capital they need. You have some mission-focused alternative sources, like CDFIs, that focus on providing working capital and financial services to underserved markets (such as minority- or women-owned businesses). The U.S. Department of Treasury provides funds to CDFIs through various programs, and businesses often have an easier time finding capital through CDFIs than a traditional bank. Your other alternative sources will primarily be found online.
However, as an emerging industry, online lending comes with its own set of issues. No matter where you go online, you will be looking at loan products that have higher fees than bank loans. So, if you qualified for a bank loan, it is almost always best to go that route.
The other issue is that it can be near impossible to figure out where to go online. Google “small business loan” and you’ll see the same value proposition from every lender that shows up on the first page (and the pages after that). Who is trustworthy? Who has strong customer reviews? Who is going to offer the lowest price? Although the online industry can be a bit overwhelming and expensive, it also has a lot of pros.
To start, you can find and secure an online loan in an incredibly short amount of time. It can take days to complete an application and get funded online, where a bank will take months. You’ll also find the applications to be less intense. They’re shorter and require less paperwork, which is always good news. But — keep in mind — the lower the cost of the loan, the more paperwork you’ll have to complete. Remember this during your search. If you only have to submit a few documents, there is a chance it will be a more expensive product.
The online industry also offers diverse products, outside of the bank’s traditional long-term loans and lines of credit. You’ve got short-term loans, SBA loans, and more.
And finally, if you are currently trying to improve your credit score, you will find that there are still options for those with less-than-stellar credit. Most likely these products will be expensive, but if your business has strong revenue and cash flow, you could certainly find a great product to help your business grow, in spite of your credit score.
Access to capital is one of the biggest challenges a business owner will face through their company’s lifetime, but the emergence of online lenders brings new opportunity and ease to the process. Hopefully, in the next few years as the industry matures, we will see clearer differentiation between online lenders and see more low-cost non-bank products, merging the best of both bank loans and alternative loans.
Meredith Wood is the Editor-in-Chief at Fundera, an online marketplace for small business loans that matches business owners with the best funding providers for their business. Prior to Fundera, Meredith was the CCO at Funding Gates. Meredith is a resident Finance Advisor on American Express OPEN Forum and an avid business writer. Her advice consistently appears on such sites as Yahoo!, Fox Business, Amex OPEN, AllBusiness, and many more.