Optimism is surging in the U.S. small business sector. With unemployment low and the economy growing, it’s understandable why these business owners are feeling increasingly confident about their prospects. According to the National Federation of Independent Business (NFIB) index, optimism from small businesses reached a 34-year high in November 2017. Not only that, but the November figures are the second highest in the 44 years the NFIB has been conducting this survey.
But the picture for small- to mid-sized businesses is not all pretty – especially when it comes to access to credit. These businesses, which account for approximately 50 percent of the private U.S. labor force and about the same percent of non-farm GDP, have historically had difficulty securing loans. In fact, according to the U.S. Small Business Administration, approximately 80 percent of all small business loan applications were rejected. This is due to the risk averse nature of traditional institutions, recognizing that these SMBs have limited credit history and cash flow numbers that don’t meet their requirements. And credit tightened even more coming out of the Great Recession, taking these challenges to a new level.
For these reasons, SMBs have been turning to alternative lending in droves. According to a University of Cambridge study, alternative finance (business and consumer) in 2016 in the U.S. was a $34 billion market. This was approximately $6 billion more than just the year before. But what exactly is alternative finance and why has it become an increasingly popular mode of business financing?
Alternative finance…can be identified as financing from external sources other than banks or stock and bond markets…often via online platforms.
The alternative finance (AltFi) market has seen tremendous growth in the U.S. and worldwide in recent years. Because of tight credit, regulatory changes and shifting consumer behavior, AltFi is becoming a mainstream solution for SMB financing. Worldwide, AltFi accounts for upwards of $150 billion of SMB financing. There are any number of AltFi platforms including everything from receivables financing to peer-to-peer lending to crowdfunding. For example, with a service like receivables financing, the SMB sells their invoice in exchange for cash, typically at a high advance rate (i.e., the percent of the invoice available for sale). This differs from other solutions which may lend against the invoices (increasing the SMB’s debt) or which lend against only 60-80% of the invoice value.
The appeal of AltFi services are many:
Newer Businesses Can Apply
Given the tight credit restrictions of traditional banks, newer businesses are often excluded right off the bat because they don’t have significant cash flow. This creates a catch-22 for a lot of these SMBs. AltFi firms aren’t nearly as restrictive when it comes to credit approval. Many firms in the receivables financing side (where businesses get their invoices paid early, for a small fee) are basing payment on the creditworthiness of the customer. How long the supplier has been in business has virtually no bearing on payment.
Lower Collateral Requirements
It's a Buyer's Market
Because there are so many providers of alternative finance right now, it’s really a buyer’s market. But it’s important for potential customers to select the option that’s best for their business and to research these offerings.
There are many options are available to optimize your working capital. Ask the right questions. Is non debt funding better for your business than a loan? Are you receiving a low rate and minimal fees? While the costs for some firms may seem low, there can be hidden fees, long-term contracts and other requirements that can make this financing more costly than you want it to be. Understand the full cost you are paying, look for high advance rates to optimize the asset and the ability to only pay for what you use.
Alternative finance is making it easier for SMBs to grow and thrive in what remains a tight credit market. Whether it’s buying inventory, securing new equipment, investing in marketing or for any number of other reasons, alternative financing is changing the way in which businesses manage their cash flow. And considering the big banks are now starting to venture into the arena by partnering with or acquiring AltFi companies, it’s only going to get better for SMBs everywhere.