While small businesses are responsible for 47.5 percent of U.S. employment, they account for only 0.7 percent of bank balance sheets, according to a study released April 29 by peer-to-peer lender Funding Circle and research firm Oxford Economics.
Though commercial lending has increased overall, banks relaxed their approval standards and interest rates on medium to large companies more than they did for small companies. And according to the Federal Reserve’s Small Business Credit Survey, small businesses face the biggest challenges in accessing credit. Thirty-two percent of businesses with between one and nine employees have a hard time getting credit compared to 18 percent of businesses with between 50 and 499 employees.
“Underwriting small businesses is more difficult and time-consuming. Besides the fact that individual businesses often lack third-party verified information [such as ratings from Moody’s and S&P], there is also a dearth of public data around small businesses,” said Mark Rambler, president and co-founder of Newark-based lender Credibility Capital. “The bar is high for traditional lenders — if they don’t have the processes in place to properly underwrite the small business, it’s not worth it for them to spend time on a small loan.”
In other words, it’s not that banks don’t want to lend to small businesses, it’s that they simply can’t do it cost-effectively.
“It costs the bank the same amount to underwrite a $5 million loan as it does a $5,000 loan. As a result, banks often avoid small business loans under $250,000,” said Kathryn Petralia, co-founder and chief operating officer of Atlanta-based fintech company Kabbage.
And though some manage to secure financing, smaller businesses are less likely to receive all that they asked for. Only 38 percent of one- to four-person businesses receive the full amount of their requests, while 70 percent of businesses with 50 to 499 employees receive what they asked for.
As a result, small businesses have turned more to fintech lenders like Credibility Capital and Kabbage. In 2016, 19 percent of small businesses seeking financing turned to online lenders. Just two years later, that number is up to 32 percent.
Fintech businesses can use automatic and machine learning to give small businesses access to credit based on real-time business data, and the turnaround time is much quicker.
On average, American small businesses took eight hours to complete a bank loan application, according to Funding Circle. A third of the customers then reported waiting one to three weeks for a bank’s decision, and 30 percent reported waiting more than a month.
According to Funding Circle, an application to finance through its platform takes only 10 minutes online, and businesses get answers in as little as 24 hours.
Joe Lanzi owns and operates Always Positive Group, an event company that runs small business expos throughout New Jersey. He has a line of credit with a bank, but uses Kabbage to fund his business expenses during the summer months, which is his slow season.
“With Kabbage, I just had to send them three statements from my bank to show my monthly cash flow and meet a minimum credit score, and then the funding was available,” Lanzi said. “With a bank, you have to go through all the hoops and wait and wait. With Kabbage, I sent the statements in and within two or three days, I had the money in my account.”
Now, after a half dozen years with Kabbage, he isn’t required to send in more banking statements, he said. They extend trust to him as a loyal customer.
“If I were working with a bank, it doesn’t matter how long I’d been with them. I’d need to fill out paperwork over and over, and wait. With Kabbage, the funds come to my account very quickly because I’ve always paid them back on time,” Lanzi said.
It’s the trust and flexibility that keeps Lanzi committed to Kabbage.
In Plainfield, real estate investor Lenwood Matthew Perry sought funding to enhance the properties owned by his company LMP Real Estate Partners. He wanted $250,000 to create parking areas, safety features, enhanced fire alarm systems, and other renovations for his properties.
He didn’t want to borrow against any of the properties, though, as they were mortgaged; and he didn’t want to put it all on credit, because the limit would be too low.
“I wanted someone to look at my overall company size and revenue, not just individual properties,” Perry said. “The guys at Credibility Capital were able to do that for me.”
Although online lenders can work more quickly than banks, small business owners should still take the time to compare offers and read every document that they receive, Rambler cautioned. They should also make sure they’re “crystal clear on the repayment terms and total cost of capital,” Petralia said, including the APR and the total out-of-pocket costs from interests and fees.
“Understanding the exact terms of the loan you’re taking out is crucial. If there’s something that you’re not understanding, it’s not your fault – it’s theirs. And it might be on purpose. So keep asking questions until you’re satisfied, or find another lender,” Rambler said.