[This is a guest post from Brock Blake. Brock is the Founder and CEO of Lendio, a marketplace for small business loans.]
Born out of the critical need for capital created by the great recession, in less than 10 years the alternative lending industry is estimated to grow into a $1 trillion industry (Charles Moldow, “A Trillion Dollar Market: By the People, For the People.”).
Many of the new business financing products have a higher than average cost of capital in order to service businesses with higher risk profiles, who can’t qualify for conventional SMB loans.
While most applaud the new-found access to capital that is provided through these new lenders, critics of this young industry say that the higher costs put undue stress on SMBs and will end up hurting them. On the other hand, advocates say that even though the costs may be higher, these loans still help SMBs start, maintain and grow their businesses.
This heightened scrutiny puts alternative lenders in a precarious position: how can they assist SMBs with needed capital while not pushing struggling businesses over the edge with unrealistic debt obligations?
I firmly believe that the overwhelming majority of alternative lenders are providing benefit to borrowers, but it’s also clear that SMBs may not be fully grasping the cost of capital, and that the communication gap between lender and borrower may be fueling doubts regarding the intent of the alternative lending space. This is why the alternative lending industry needs to move to close the communication gap between lenders and borrowers, and to do so by using all relevant metrics to articulate the cost associated with a loan as clearly as possible.
Here are two questions lenders need to consider to effectively communicate the cost of capital.
1. Does this loan provide benefit to the borrower?
Specifically, what does the business owner need the money for, how quickly do they need it, and will the financing improve the borrower’s situation?
The borrower’s situation is important for several reasons. First, the only way for an SMB owner to evaluate the cost of capital is to consider it against the cost of NOT getting capital: what is the cost of not bulking up inventory, or of not making a critical hire? If the upside from getting the capital in a timely fashion is just incremental, the cost of capital needs to be considered carefully to make sure that the benefits outweigh the limited upside. On the other hand, this could be less of a concern if the upside is significantly greater than the cost. Second, borrowing money for cash flow for several weeks or months is very different from taking out a loan that will be paid back over years and is secured by an asset that can be sold (which is why credit card rates are so different from rates on mortgages). What’s most important to a borrower who needs an infusion to help manage a temporary cash flow situation is not the same as what’s important to a borrower investing in heavy equipment that will depreciate as it’s paid for over years. And third, while we’ve all heard the truism “time is money,” to an SMB owner that may literally be true. The flexibility to act on an opportunity or implement a strategy in a timely fashion may pay for itself in the short or long term.
Fortunately for the business owner, the alternative lending industry has opened a whole new world of loan options to help solve the cash needs of the business that owners didn’t have access to previously. These products not only help smooth cash projections, but SMBs are also able to seek funds on short notice when they find themselves in a cash crunch. The flexibility and the speed at which these loans can be funded is an important need that the alternative lending industry is meeting. While the typical time for a business to obtain funds through traditional lending sources is 60-90 days, alternative lenders are able to provide funding in 2 to 10 days. That being said, it is critical that the lender take the time to understand the borrower’s situation and priorities — learning about what’s most important to him or her. [Read more…]