According to Karen Mills, with the credit crunch that ensued in the fallout of the Great Recession, it became clear that, “traditional small business bank lending model has...gaps that, with the help of technology, challengers are finding promising and profitable.” These “challengers” are online lenders and they are gaining in popularity because, with their expansive lending models and fast approval process, they are making it easier for more small businesses like you to quickly get access to the cash you need to grow your enterprise. If you are finding it difficult to obtain a loan from your local bank, you may be interested in using one of these online lenders. If so, please pay close attention to the following information before making your final decision.
Online lenders can be separated into three categories:
1) Short-Term Lenders
a. These typically have loan terms of less than nine months.
b. Lenders are paid a fixed percentage of sales, etc. deducted daily from the business account. This can lead to extremely high annualized percentage rates of between 30 percent and 120 percent.
c. The average loans size is $40,000
d. E.g. of online lenders: OnDeck Capital and Kabbage
Drawbacks of short-term online loans:
• Borrowers have to pay pre-payment penalties for early repayments.
• Because of the high rates on these loans, if they’re not mindful, some borrowers can get stuck in expensive cycles of re-borrowing.
2) Longer-Term Peer-to-Peer Lenders
a. The capital for these loans are provided by investors.
b. Peer-to-Peer lending is similar to traditional bank loans in that:
i. They “offer amortizing loans with fixed interest rates and three to five year maturities”.
ii. Unlike the exorbitant rates charged by short-term online lenders, the peer-to-peer lenders charge rates of 6% to 24%.
iii. They have loan amounts of about $240,000.
iv. They don’t tend to charge pre-payment penalties.
v. E.g. of peer-to-peer lenders: Lending Club, Prosper, Funding Circle and Fundation
3) Online Lending Marketplaces
a. These sites help borrowers easily compare the products, rates and other factors of different lenders.
b. They help borrowers save time and quickly find the funding they need.
c. Per Mills, these sites “earn revenue by charging a small fee on top of the loan if the borrower gets funded and accepts the terms of a loan from its platform.”
d. E.g. of online lending marketplaces: Biz2Credit, Lendio, and Fundera
ADVANTAGES OF ONLINE LENDING INSTITUTIONS
More Expansive Lending Model vs. Traditional Banks
Traditional lenders look at a narrower list of factors when making loan decisions (such as the owner's personal credit and other key business metrics).
Online lenders, on the other hand, not only use the factors considered by the traditional banks, they also consider things like (but not limited to):
• Current cash flow
• Performance of the small businesses using a sources
• Social media success
ISSUES RELATING TO ONLINE LENDING
Per Mills, there are some concerns surrounding online lenders that you should before taking the plunge:
• Transparency and Disclosure
There are concerns about the relative lack of regulation of the online lending market. Plus, it is not clear if all the lenders are correctly disclosing the terms of each loan to the borrowers beforehand.
• Questions of Standardization
Because of the lack of regulation, there are concerns that there is limited standardization among the products offered by online lenders; this could lead to greater confusion among borrowers.
Though there is concern that too much regulation would tamper innovation and new entrants into this emerging market, there is the question of oversight and monitoring. Per Mills you should be aware that,
a) There is concern that online lending to small businesses could become the next subprime lending crisis.
b) Though the SEC and state laws regulate peer-to-peer lending, "the online small business lending sector is largely unregulated" by the federal government.
Now that you are properly informed...