The 2008 recession knocked small business loans for a loop, and they still haven’t fully recovered. But owners have more options today thanks to new online lending platforms. It’s still tough to get a small business loan, however, and also a little confusing.
How can you make sense of the changing landscape?
NerdWallet spoke with former SBA Administrator Karen Gordon Mills about the availability of bank capital for small businesses, the rise of alternative online lenders and how small businesses can take advantage of the new lending choices.
Mills was SBA administrator from 2009 to August 2013. She is now a senior fellow at Harvard Business School and the Mossavar-Rahmani Center for Business and Government at Harvard Kennedy School.
NerdWallet: You’ve talked about the still-tight credit market for small businesses in your Harvard Business School working papers and articles. What is the state of small business lending today?
Mills: Certainly better than it was a few years ago. But access to capital for small businesses is actually one of the areas that has continued to lag behind the pace of overall economic recovery. In fact, if you look at loans of less than $1 million, which isn’t a perfect measure but one of the best we have since most of these do go to small businesses, loan volume dropped 18% during the recession, leveled off to about $600 billion and has pretty much stayed there in the years since.
This points to a significant drop in the market, and the gap seems most concentrated in the smaller-dollar loan market, which is what most small business owners are looking for. According to the Federal Reserve’s Fall 2013 Small Business Credit Survey, 70% of the respondents said they were looking for loans of $250,000 or below.
Why isn’t bank lending recovering?
There are several reasons we still see gaps, including a few key dynamics in the chief source of capital for small businesses — the traditional banks. First, traditional banks have not found an economical model for making small-dollar loans. It costs them just as much to make a loan for $150,000 as it does to make one for $1 million. Second, the traditional sources for small business loans are disappearing. Community banks, which have traditionally supplied close to 40% of the loans to small businesses, are being consolidated. As recently as the early 1990s, there were about 14,000 community banks in the country, and now there are only about 7,000, and that number continues to decline.
How are alternative lenders helping to fill the small business lending gap?
The short answer is their growth is rapid, but they are still only a small portion of the total market. It’s actually quite an interesting case study. It’s an instance where entrepreneurs are actually stepping in and driving innovation to solve a problem for other entrepreneurs and small business owners. And, they are doing what entrepreneurs do best — they are disrupting. And in this case, that disruption is happening in an industry that hasn’t changed much in the last 30 years.
Overall, online lenders still only account for a small fraction of the total loans to small businesses across the country. But they are the fastest-growing segment among sources of capital for small businesses.
Think about it. Today, small business owners walk into a bank and apply for a loan in much the same way that their parents or grandparents would have. Lots of paperwork and an approval process that can take weeks or even months. Leveraging new technology, online and mobile access and new algorithms, the new online lenders are offering application and approval times in a matter of days, if not hours.
Now, we’re still in the early days of the growth in this market. Overall, online lenders still only account for a small fraction of the total loans to small businesses across the country. But they are the fastest-growing segment among sources of capital for small businesses.
With new alternative lenders coming into the market almost every day, how can small businesses take advantage of these options?
Access to these new sources of capital is actually quite easy, thanks to the increased ease of Web and mobile technology these days. And [they’re] not just easy to find, but because of the technology behind their systems, it’s easy to apply. This is a factor we can’t overlook when we think about the market growth potential for online lenders. Why? Small business owners are busy running their business. Taking the time to work through a traditional bank loan application process is time away from their business, their employees and their customers. So you can quickly understand why a streamlined application process via an online lender is something that captures their attention.
Should small businesses be wary of these alternative lenders?
I feel that the growth in the online and alternative lending sector is on the whole a positive for small businesses in that it increases the points of access they have when it comes to getting the capital they need. But that doesn’t mean that they shouldn’t do their homework. This is still an unregulated industry, and the lending models being used by these online lenders vary greatly and the costs can sometimes be quite high. My advice to any small business owner is, take the time to dig into the details and make an informed decision that’s right for you and the type of capital your business needs.
How can they evaluate these new online lenders?
There are many new lenders online. Each offers different types of loans for different lengths of time and with different conditions and costs. Knowing the different types of lenders is important, but also knowing what type of capital your business needs is even more important — working capital, financing for inventory, growth capital or asset financing.
A small business needs to do a lot of thinking and forecasting about how much cash it needs, what it will spend the money on, and when it will be able to repay the loan. If a business needs $50,000 to build holiday inventory, it might look at a short-term working-capital loan, whereas a larger loan to buy a piece of equipment might be better financed as a term loan. The homework also has to include knowing the total cost of the credit. The interest rates across the online lender industry varies, as well as the manner in which that interest is collected — sometimes daily draws on your account, while others may be more like traditional loans.
Last, look at what others have to say about the online lenders you’re considering. You really do need to comparison shop and learn from other small business owners’ experiences. Be sure you have mapped out a realistic forecast that allows for all the loan costs and makes sense for your business.
To get more information about funding options and compare them for your small business, visit NerdWallet’s best business loans page. For free, personalized answers to questions about financing your business, visit the Small Business section of NerdWallet’s Ask an Advisor page.
Images via iStock and Karen Gordon Mills.