Online small business lending: What you don’t know
Not too long ago, making recommendations about small business financing was pretty straightforward. That’s not the case today.
Accountants and CPAs are in a unique position to counsel their clients on everything from the tax consequences of an upcoming business decision, the business entity they should assume, to whether or not financing is even something they should pursue to fuel business growth or meet some other business objective.
With all the available options, business owners need to be better informed and more savvy about small business finance. The last few years have seen a lot of changes in how small businesses access capital — which makes it difficult to stay on top of what’s available and make sense of the type of business-use cases where you might consider recommending an online business loan, a traditional loan at the bank, or some other type of financing.
While speaking to accountants all across the country, I’ve recognized some pretty common misconceptions about online small business lending and wanted to address a couple of them here.
Misconception: Online loans are just too expensive
While this may be the case in some situations, depending upon why your client is borrowing and the individual lender, this might not be an accurate blanket description. In my opinion, loan purpose (or the reason your client is borrowing) informs a lot of the decisions they’ll have to make, particularly regarding the cost of capital and whether a particular loan option makes sense.
The Electronic Transactions Association (ETA) in March commissioned Edelman Intelligence to conduct an online survey of 592 small business organizations to learn more about their experience with online lenders. The results are quite interesting.
Although it might feel counter-intuitive, the lower total dollar cost of some online loan options were a determining factor in why a small business chose an online business loan. Total cost of financing is a very important metric for financing growth initiatives or other loan purposes with a defined or reasonably expected return on investment. Depending upon the loan term, it’s possible for a higher-APR loan to carry a lower overall dollar cost and make sense given a particular business use-case.
The majority of the small businesses surveyed were more focused on the total dollar cost of the loan than the APR when facing a hypothetical short-term opportunity to capture additional ROI. In fact, 57 percent of them chose a six-month loan over a nine-month loan (with a lower APR) in order to minimize the total fees and expenses. While APR is a reasonable way to compare two loans of the same term, it does not provide the total dollar cost of the loan.
The business owners in the survey additionally reported they expect an average return of $5 for every $1 borrowed—which may be why they are so focused on total cost. The two most common reasons for borrowing were to purchase equipment (54 percent) or to purchase inventory (51 percent); both purchases are very dollar cost sensitive.
Misconception: Online lenders are a last resort
You may assume that online loans are the loans of last resort. It’s a common perception. Nevertheless, today many small businesses turn to online business loans for financing with the three primary reasons identified by the ETA survey being:
1. They can access the capital quickly (63 percent);
2. The application process is simple and straightforward (57 percent); and
3. The costs are reasonable (51 percent).
Admittedly, not all online lenders are created equal, and as is the case in every industry, there are good players and those you may not want to do business with. However, it’s really a matter of looking at small business creditworthiness through a different lens and with a different paradigm — not a disregard for good credit practices — that allow them to approve small business loans that might have been rejected by a more traditional approach that is largely driven by a personal credit score.
While for most small business owners their personal credit score will likely always be part of the equation, I’m not convinced it should be a go/no-go metric for credit denial when there are so many other data points available that may provide greater visibility into a business’ creditworthiness. What many of these online lenders are doing is leveraging technology and big data to go beyond a credit evaluation based largely upon a business owner’s personal credit score.
These are important considerations that are reflected by the 96 percent of those surveyed who identified they were borrowing to enable growth. Access to capital can be a major challenge to many of the small business owners you advise. An online business loan is one of the options you have available to help them find the capital they need.