Why You Should Consider Online Lenders to Finance Your Business

Why You Should Consider Online Lenders to Finance Your Business

If you are a small business owner seeking a business loan, you should consider an online lender. While these creditors — companies like OnDeck, Lending Club, Prosper Loans Marketplace — currently account for a tiny fraction of all small business finance, they are currently the most rapidly growing source of small business debt.

That’s according to Karen Mills, the former head of the Small Business Administration and now a Senior Fellow at Harvard Business School explains (PDF).

In fact, the Federal Reserve Bank of New York has found that 20 percent of small businesses seeking to borrow money have applied to online lenders.

While loans from online lenders are often more expensive than other forms of small company credit – interest rates are similar to those of credit card loans – small business owners should consider online lenders as a source of financing for several reasons:

First, many online lenders offer products that match the financial needs of small business owners better than many products offered by banks.

These days, many small business owners need small amounts of money to meet short-term cash flow pressures rather than term loans to finance major purchases.

Analysis by the consulting firm Oliver Wyman shows (PDF) that many online lenders focus on smaller and shorter term loans and offer cash advances against accounts receivable, which is the kind of credit many small business owners with “lumpy” cash flow need to match their inflows and outflows of money.

Second, online lenders offer queaick and simple loan applications.

Small business owners are often time constrained as well cash constrained and need access to credit without spending hours on paperwork. Online lenders typically have much simpler application processes than banks and are far faster at making loan decisions. Instead of taking a few weeks to make a loan decision, online lenders typically take only a few hours.

A survey of small business owners using its services conducted by online lender OnDeck found that many small company owners had turned to online lenders after having rejected traditional loans as “too difficult” or “too slow.”

Third, you may be more likely to obtain a loan from an online lender than from a bank. Online lenders sometimes find borrowers rejected by banks to be creditworthy because they evaluate small businesses differently.

Rather than focusing solely on the criteria employed by banks, some online lenders use complex algorithms that include information from online social networks to predict the odds that borrowers will repay their debts. Others rely on the preferences of individuals seeking to invest their savings directly in other people’s companies.

Those algorithms and preferences sometimes yield different results than the decisions of bank loan officers.

Fourth, you may soon have little choice but to look for an alternative to a bank loan.

The high costs and low profits of small business loans have pushed many banks to exit the small business loan business over the past twenty-plus years. Between 1995 and 2014 loans of less than $1 million dropped from 33 percent of all commercial and industrial loans to 21 percent.

Moreover, community banks – the most likely to lend to small companies – have been disappearing. Since the financial crisis, the Federal Reserve Bank of Richmond found that their numbers have declined by more than 40 percent.

The emergence of equity crowdfunding will likely to boost the amount of external equity small business owners raise. However, loans are a better source of financing than equity for some small businesses.

As a result, many small businesses that have historically been financed with bank loans will continue to be financed with debt. Some of that debt will come from online lenders.

Image: OnDeck


Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

4 Reactions
  1. It’s nice to hear that small business owners have a lot of opportunities to grow. They are no longer tied down by banks and offline money lenders. They now have a lot of options.

  2. If you carefully read ONDK’s S1, you will see the average interest rate or IRR, is about 54%….But, they never state it on the docs. So, do your math before you sign the papers….

  3. How to apply so that I can grow my small business