Banks are the principal source of outside capital for small businesses, but there have always been alternative forms of loan capital available, including credit unions, Community Development Financial Institutions (CDFIs), merchant cash advances, equipment leasing and factoring products.
Historically, this segment of the market has been small compared to the $700 billion in small business bank credit assets. But since the onset of the financial crisis, and particularly during the economic recovery, there has been significant growth in innovative, online alternative funding for small businesses. The outstanding portfolio balance of online lenders has grown about 175 percent a year, compared to a decline of about 3 percent in the traditional banking sector. However, it still only represents less than $10 billion in outstanding loan capital.
The first wave of tech-based alternative lenders included companies like OnDeck Capital and Kabbage and can be referred to as online balance sheet lenders. Their loans typically are short-term, less than nine months, and fund working capital and inventory purchases. Many of these loan products operate similarly to a merchant cash advance, with a fixed amount or percent of sales deducted daily from the borrower’s bank account over several months.
Clearly new online entrants present a challenge to established players in the small business lending marketplace. They have been on the scene since 2007, but momentum has increased significantly in the last 12 to18 months. Lending Club recently filed for an IPO with a valuation of approximately $4 billion, and OnDeck is preparing an IPO later this year that has been valued at $1.5 billion.
While the online market is in the earliest stages of transformation, it is clear that the traditional small business bank lending model has left gaps that, with the help of technology, challengers are finding promising and profitable. This should benefit small businesses who, despite having to deal with higher interest rates in some cases, could find more transparency in product and pricing options, lower search costs, and better speed and customer service.
Online Banks Fill Funding Needs for Small Business .