I’ve become somewhat known — and sometimes criticized — for being an opponent of “alternative lenders.”
My critics think that I am against the alternative-lending industry as a whole. This isn’t necessarily the case. In fact, in our loan brokerage we put business owners into alternative loans when we can’t get them bank or SBA loans, and we get paid for it.
There will likely always be a population of businesses that are not bankable and cannot get a loan backed by the U.S. Small Business Administration. Owners of these firms are left to turn to alternative lenders, even though the funds will generally come at a much higher cost than what’s offered by an SBA lender or traditional bank.
That being said, in an efficient market, alternative lenders could be a means to an end, a stepping stone for a small business to affordable and sustainable funding.
While “alternative lending” is a hot buzz word today in the press and with venture capitalists, it’s really not a new phenomenon. It started decades ago with factoring, in which lenders advance money to a business based on work they’ve invoiced and completed. This product can help a small company stay afloat as it works to become profitable and bankable. But factoring is only an option for companies that sell products or services to other businesses on terms.
Next, came the birth of the cash-advance business. Loans provided by these companies typically come with six-month terms, with the principal and interest being debited out of the borrower’s account in daily increments. On average, such firms charge an annualized interest rate of between 20% and 60%, and sometimes as much as 200%.
In some instances, these transactions are constructed as advances where the lender buys a future piece of the company’s receivables. By structuring these deals as an advance, the lender manages to avoid usury lending laws. That said, from the borrower’s perspective, it’s effectively a loan and that’s how I like to think of them.
Can you imagine buying a car and having six months to pay it back with payments starting on the first day you drive it off the lot? Hard to stomach? So what often happens is that the borrower needs to reload or renew the loan after just a few months to get more time to pay it off. And as this cycle accelerates, interest fees accrue, and the borrower is stuck in a viscous cycle that he or she can’t escape.
I want to be clear that in our loan brokerage we occasionally put customers into these loans. But we only do it after we have exhausted all other options, and made sure the client has a plan for making the necessary payments on time.
Fortunately, the alternative-lending landscape has evolved over the past few months. New alternative players have arrived such as Dealstruck Inc., Fundation Inc., Funding Circle Ltd. and LendingClub Corp. and on average, they charge an annualized interest rate of between 6% and 29%. They offer borrowers up to five years to pay loans back with no or minimal pre-payment penalties. This is a good amount of time for a business to make an investment and pay back what it borrowed
We’ve also recently seen the launch of SmartBiz, an SBA Express program that is leveraging technology to offer borrowers up to 10 years to pay back their debts.
Borrowed money should always be seen as a means to an end. In some cases, the “end” is to pay the loan off, and in others the “end” is entering into an affordable, secure bank loan.
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