NEW YORK (MainStreet) Mike Cordero, owner and chef at A-Town Bar & Grill in Arlington, Virg., faced challenges in the wake of the Great Recession to secure the funding from a national bank he needed as working capital to renovate his gastro-pub.
It wasn't his faultwhat with his solid credit score and established business reputation. But in the post-crisis environment, traditional lending has frozen up. Though there are some indications of thaw, traditional banks are reluctant to invest with small business, a pursuit they view as risky.
In fact as of March 31, small-business loans from banks dipped 18% to $584 billion from a $713 billion high in 2008, according to the Federal Deposit Insurance Corp.
That's where a tale of two markets emerges: banks who lend to companies with a substantial profile and alt lenders, such as RapidAdvance, who appeal to Cordero and others like hima more expansive, eclectic group. Sure, there's much buzz about the rise of crowd-funding to secure financing, but much of those efforts target true start-ups. What about already established small businesses looking to refurbish or open up a second or third location?
It's for this scenario that the alternative lending space is growing at a rapid clip as traditional banks pair with these platforms.
"Traditional lenders like the banks are recognizing the value in partnering with alternative lenders to service the small business customers who bank with them," said RapidAdvance CEO Jeremy Brown. "They recognize having the ability to utilize lenders with alternative underwriting criteria enables them to access financing for their clients that may not fit their traditional criteriaenhancing the overall relationship with the customer."
In fact, the Green Sheet appraises the current market for merchant cash advances at between $500 and $700 million, with the potential to reach a robust $4 to $5 billion in the ensuing few years.
Another key development has been the rise of aggregators/feeders who offer match.com-like marketplaces that serve to funnel business referrals to lending sources have added alternative lenders as a key component to better serve the small business community.
To be sure, the field of alt lenders out there is rapidly expanding. OnDeck Capital, for instance, recently netted big investments from Peter Thiel and Google Ventures. Kabbage, another alt lender, uses QuickBooks data and trumps a Small Business Administration Loan by offering fees from 2% to 10% in the first two months of a loan before charging 1% for the last four months of the loan.
"There are literally hundreds of companies trying to lend money to small business owners in the alternative lending space, as a result of the credit crisis," said Ami Kassar, CEO and founder of MultiFunding, a small business planning and lending firm in Philadelphia. "In light of all of these options, it's critical that a small-business tries to get at least a few options if they're looking for money, makes sure they understand the loan and all of the associated expenses very carefully, and that they have a business plan that makes sense for the financing."
In weighing the pros and cons of various options, it's not all hunky-dory.
Companies such as Advance Me and RapidAdvance, backed by Wells Fargo, can sometimes charge rates that exceed 100% depending on the lender.
Still, the bank business model for lending to small businesses has changed very little over the last five years and does not accommodate smaller loans or lending to businesses with less than perfect track records. While the banks may be back in some form, they have largely ceded a significant portion of the small business lending marketplace to alternative lenders.
So as small business owners tap this option, there are two major caveats they should heed, according to Kassar.
- 1. Understand the APR of their loan clearly. If they are borrowing $10,000 and paying back $12,000 over three months as an example, the interest rate is not 20%--it is at least 80%.
- 2. If the lender is taking a percentage of the business's credit card sales, don't confuse the daily percentage with the interest rate of the loan. As an example, if the lender will be taking 10% of your daily credit card deposits until you pay them back, don't confuse this with a 10% interest loan.
Small business owners must tread carefully, but given the tight credit environment and a JOBS Act has not been fully implemented from a legislative standpoint, they are increasingly relying on the alt lending model to advance.
"The JOBS Act is scratching the surface in terms of its ability to help fund companies," Kassar said. "Unfortunately, alternative lending options are a way of life for millions of small-business owners who don't have other options. Therefore, it's critical that the small-business owners understand exactly what they're getting themselves into, if they choose this option."
That said, the industry's value proposition of ready access to capital and more thoughtful reviews of potential borrowers, is driving an influx of interest from borrowers who see opportunity to grow and expand their businesses in a stabilizing economic climate.
"[Small business owners] are finding that alternative lending is complimentary to their traditional financing or in many cases because of the access and uniqueness of the capital a better fit solution for their business," RapidAdvance's Brown said.
--Written by Ross Kenneth Urken for MainStreet