While most business owners are always juggling cash flow, profitability management, and access to capital, not all of them have had true relationships with their banks or the SBA. Business owners have for years talked about the time-intensive and onerous process of securing SBA funding. Most have turned to the banks, and when turned away there, have gone the only route available—alternative finance lending.
But the business realities, and in many cases, horrors, brought on by COVID-19 and many states stay at home orders, have caused several interesting dynamics:
- The demand for capital has caused owners to seek help everywhere.
- The demand for immediacy has required the SBA and financial institutions to upgrade outdated tech that had previously created a market for fintech finance companies.
- The access to far lower priced capital has challenged the, sometimes predatory, market pricing for capital that alternative finance companies commanded.
Changes in capital players and choices for small business are shifting the capital marketplace.
Open season on sources of capital
Leaders in alternative finance have long known that many of those seeking loans have issues that make them “undesirable” to traditional lenders. The issues that compromise a borrower’s attractiveness include high risk/bad credit history, operating a business at a loss, operating in a commoditized industry, cash flow ignorance, and more.
Given the rapid dynamics that hit nearly every market in the face of COVID-19, the standard definitions for risk went out the window. Instead, the market has been redefined as “businesses of every size and sophistication that need capital and need help getting it.”
Those who under ordinary circumstances might only have the assistance of alternative-finance providers have now been grouped back in with the masses. Bankers, the SBA, local, and state lending partners all played a role in helping everyone understand their lending options. According to the NFIB, the National Federal of Independent Business, nearly 70% of all small businesses applied for the PPP, and 50% filed for an Economic Injury Disaster Loan (EIDL). Those that didn’t get the PPP are exploring a range of other programs, now with a new set of partners.
Technology enhancements – user experience and speed to capital
One of the advantages that fintech finance companies have had in recent years—and they tout it in all their advertising—is the speed at which they can deliver funds into business owners’ accounts. This speed is due in large part to the efficiency of the digital underwriting and transfer processes.
But the last mile of money going from lender to borrower has only been a small part of the challenge. Many large banks and traditional lenders have struggled not only to implement mobile-centric capital transfer technology but to transform and digitize their underwriting processes. If you’ve gotten a mortgage from a conventional lender, and refinanced with someone like Rocket Mortgage, you’ll understand the difference. The former often requires weeks and hundreds of documents faxed, emailed, and manually signed, in contrast to a clean, central repository of uploaded documents followed by a series of e-signatures in minutes and hours.
The COVID-19 lending flurry highlighted similar contrasts. As banks, and the SBA, moved to update their user portals, their uploading capabilities, their online calculators, virtual help features, and call centers, companies like PayPal and Kabbage were in many cases finished with applications and funding. Time is indeed, money.
As someone who has navigated the user experience with banks, the SBA, and alternative lending sources, the differences are stark. I will say that the SBA and, to some extent, banks made warp speed enhancements in contrast to the typical technology lifecycle. It was not without worts, interface time outs, confusion, and frustration, but they kept at it and continue to refine their infrastructure to be relevant in this century.
A disruption in the cost of capital
While traditional commercial lending backs much of our economy, through trillions in loans annually, the small business or “main street” space operates in a different reality. This is where newly unfolding dynamics may redefine the cost and accessibility of capital for some time to come.
Ordinarily, high-risk borrowers have high-priced borrowing options, and lower risk institutional borrowers have access to more reasonably priced capital. High-risk, high-priced capital, moves fast—fueled by the common condition of desperation. Low-risk, lower-priced capital moves slowly, and sometimes not at all.
To put the size of the alternative lending market in perspective pre-COVID-19, Moody’s Analytics sized the alternative lending market in 2015 at $47 Billion. By late 2019, Business Insider projected a 2020 market size of $100 Billion. The market was huge. It was supporting a tremendous amount of innovation and capital, and it was greasing the skids of an immense number of small businesses that didn’t have other borrowing options.
In contrast to alternative finance, the SBA in 2019, through its “flagship 7(a) loan program, made approximately 52,000 7(a) loans totaling $23.17 Billion. The 504 loan program had another year of increased performance, with more than 6,000 loans made for a total dollar amount of more than $4.9 billion.” Those loans are critical to the 58,000 borrowers that took advantage of them, but they pale in contrast to the size and impact of the CARES Act.
According to Foley & Lardner, with the introduction of the CARES Act, some $659 Billion in lending was released to the market. Most of this funding is intended for small businesses, which makes up the lion’s share of the alternative finance market. The influx of this capital—at lower rates than typically charged by non-traditional lenders—could disrupt the available market for alternative lenders, albeit temporarily.
GUD Capital, a business loan brokerage, puts the typical speed and price of capital in perspective in this table.
GUD Capital outlines rates, terms and speed of funding types.
Now, add to this table, the SBA or Treasury-backed programs—like the PPP and Disaster financing—that provide loans at 3.75%, with terms up to 30 years, that can be funded in 3 to 10 days. The impact of this cost of capital, combined with the speed of funding, isn’t evolutionary; it is revolutionary.
Even those not typically interested in financing, lending, and banking have been overtaken by the concern and innovation occurring related to these issues. Just like health, money is a topic that affects everyone.
In an election year, when most headlines are typically devoted to poo-flinging, there has been a monopoly on digital ink by the financial sector fueled by the people’s real needs. Who knows, perhaps access to capital will become the social justice topic it has long deserved to be.
The focus on gender-preference in pronouns may be replaced for a bit by lending status and progress. Perhaps some of this contract tracing wizardry that will soon create the latest discrimination-class—COVID-positive citizens—can be used to trace the flow and cost of capital to those small business owners that are too often left out.
No doubt, alternative finance will continue to evolve as it has, very rapidly, with a correct focus on customer-centricity and user experience. As the cost of capital has come down, let’s hope it is still worth alternative finance’s while to offer it. Let’s also hope that investors continue to fund innovation in the alternative finance space with the same excitement now that their investment horizon may be further in the distance.