I recently read an article by Karen Mills, former administrator of the U.S. Small Business Administration, about technology's evolving role in small-business loans. In her article, Mills suggests that "new, nonbank lenders are using technology to take complexity and time out of small-business loan making." In most instances, I don't think she is correct.
Some benchmarking is necessary to frame the discussion. If you look at the data of banks, which are required by the FDIC to file quarterly call reports, there are just over 22 million business loans on their books with balances of $1 million or less. But if you dig deeper into the data, the vast majority of these loans (21.25 million) are categorized as having balances from $0 to $100,000. And the average balance of these loans is less than $10,000.
I argue that these 21.25 million loans are predominantly from business credit cards, in which decision making is automated and made in seconds with money available rapidly. These loans differ significantly from the world of the 937,000 loans on banks' books with balances from $100,000 to $1 million. These loans are harder and slower to get, and almost always involve judgmental underwriting and human intervention. Underwriting and closings can take weeks, if not months.
So where is the innovation happening that Mills describes? The predominant activity in the past few years has been new venture-backed short-term loans, from lenders that typically offer small-balance loans with money debited daily out of the customers' accounts. These lenders tout the speed at which they can get money to a business as a big part of their innovation. But the vast majority of their loans, at least to date, are falling in the under $100,000 category that is primarily supported by banks today through credit cards.
Though this is an innovation in the respect that there is a new loan product and mechanism, it's not saving customers time nor revolutionizing bank lending. And in most instances, in my opinion, a credit card is a better avenue to travel than a cash advance or short-term business loan when it comes to financing an operation. Unlike cash advances and daily debit loan options, which pose short amortization periods, credit cards offer more flexibility and more affordable repayment terms over a longer period of time. Most businesses would rather make monthly payments on a credit card and have the ability to revolve balances than be in the hands of a new alternative lender that is debiting their bank accounts at the close of business each day.
You could argue there is innovation if the alternative lenders have created a form of subprime credit card and they are getting capital into the hands of those who couldn't get a credit card. But I don't think there is an argument to suggest their loan product is better than a credit card or is challenging traditional larger small-business lending.
In my opinion, the real innovation will come when there are alternative lenders that are able to go after the market of loans from $100,000 to $1 million--those which take time through traditional underwriting methods and are tough to get. One of the larger short-term lenders, OnDeck, will underwrite as much as $250,000 on its daily debit platform, but the vast majority of its loans are smaller. We've also started to see lenders such as Fundation and Funding Circle offering faster traditional-term loans of up to $500,000, and DealStruck is offering loans of up to $250,000 with much faster turnaround times than traditional banks'. Their prices are higher than traditional banks', but it's fair to say that in their category they are significantly cutting lead-times. That being said, these platforms are still in their infancy and just starting to scratch the surface.
Innovation in small-business lending is an important goal. I hope my thoughts help with perspective about where the important developments are.