Small Businesses Eye Alternative Lending

Small businesses and start-ups seeking financing are still finding it hard to get loans despite loosening lending restrictions, and alternative lenders are beginning to take notice of a …

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Small businesses and start-ups seeking financing are still finding it hard to get loans despite loosening lending restrictions, and alternative lenders are beginning to take notice of a growing opportunity. Merchant cash advance companies, micro-lenders, Community Development Financial institutions and other non-bank lenders approved two-thirds of the applications submitted to them in January, according to lender-borrower matchmaker Biz2credit.com. Mainstream lenders and even Small Business Administration loan programs have ratcheted down business in the midst of government banking reform, leaving the door open for new sources of capital and small businesses are taking advantage. For more on this continue reading the following article from TheStreet.

Even as credit starts to flow again timidly at traditional lenders, small businesses — particularly start-up companies — are still having trouble getting financing. Many have turned to alternative lenders. And now bigger, more recognizable names finally smell opportunity in the alternative lending space.

Small-business loan approval rates by community banks and nonbank lenders spiked in January to their highest levels in the past 12 months, according to the monthly Small Business Lending Index, which analyzes loan applications through Biz2credit.com, which connects borrowers with more than 1,100 lenders nationwide.

Alternative lenders in particular — Community Development Financial Institutions, accounts receivable financers, merchant cash advance companies, microlenders and others — approved more than two-thirds of applications from potential borrowers last month. That compares with the approximately 47.5% of loan applications approved by small community banks and just 11.7% approved in January by banks with more than $10 billion in assets, Biz2Credit says.

"Over the last three and a half years, a lot of banks have shrunk their branch network. That has disrupted the old relationship dynamic and created a huge vacuum in the market for working capital for businesses to run their day-to-day business," Biz2Credit CEO Rohit Arora says.

Additionally, SBA programs — particularly the SBA Express program more geared toward working capital — "really suffered because of the fact that the bigger banks were the main users of that program. So that created a double whammy and no way for small businesses to get the money," Arora says.

That led to the rise of alternative lenders. Initially it was some of the CDFIs, microlenders and credit unions, types of lenders without much experience in such things as cash advances and factoring, Arora says.

"Over the last year what we are starting to see is that kind of funding is coming from more mainstream lenders because of all these different reasons. It is also creating the pressure on the banks and other institution to go out and start lending again to businesses," Arora says.

The main difference between alternative lenders and more traditional lenders is the terms of the funding. Typically, money is available quickly, but borrowers pay much higher interest rates. "Normally the downside of this money is it’s more expensive," Arora says. "The market is not regulated, so there is no cap on the interest rates. This usually leads to more defaults and more businesses going out of business just from the fact that the cost of capital is so high."

That’s changing. The cost of funding in this asset class has begun to drop from an average 27%-28% to 16%-18%, Biz2Credit says. As more players enter the niche, interest rates will lower even further as competition heats up.

Here are three examples as provided by Biz2Credit:

1. American Express(AXP) launched a merchant financing program recently that provides cash advance for merchants with an interest rate of only 6%.

2. Accel Partners, investors in Facebook, Groupon(GRPN) and Etsy, announced plans last week to inject $30 million into Capital Access Network — the largest alternative capital provider to small businesses in the U.S., funding more than $2 billion in capital under the brands NewLogic Business Loans and AdvanceMe.

"From our work with small businesses, it’s clear that one of the most pressing issues for merchants is access to credit and working capital," Accel partner Kevin Efrusy said in a statement. "Especially today, banks are unable to play effectively in this market. Large institutions cannot reach, evaluate or serve small businesses efficiently. Many newcomers to the finance space are constrained by limited access to and very high-cost capital combined with high portfolio losses given unseasoned risk-scoring models. Capital Access Network has by far the strongest team, scale and data-driven approach to this market."

3. Stone Point Capital is investing $100 million into Access Point Financial, a venture it created to provide financing to the hospitality sector.

More big names plan to launch alternative funding products in next two months, Arora says.

What you need to know
Businesses should do their due diligence on lenders and be prepared.

"Access to credit is a lot better compared to the last three years. The challenge today is, unlike 2007 where you go into a bank and got a [quick] approval, that’s not going to happen. You have to be prepared. You have to have financials in place, a business plan and you have to be ready to say how you will use the money and how you will pay us back," Arora says.

While 2012 looks better, small-business owners should still be aware of the macro-economic conditions.

"If they’re planning to do something three or four months down the line, then they should do it now, because market sentiment is better. Over the next three to four months, nobody knows what’s going to happen. If things turn again, it will impact access to credit," Arora says.

This article was republished with permission from TheStreet.

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