Despite its flaws--extremely high interest rates, onerous terms and poor transparency--short-term online business lending has proliferated in recent years.
In a just-released Federal Reserve survey, 30 percent of microbusinesses (revenues less than $100,000) and 22 percent of small businesses (up to $1 million in revenues) said they had applied at an online lender in the past 12 months.
The reality is that the majority of the people looking online don't think they'll get a better deal--or any deal--from traditional lenders. Usually, they're not eligible for Small Business Administration (SBA) lending or bank loans or they think they aren't eligible. More on that later.
In other words, those seeking help from online lenders are likely poor credit risks. That doesn't mean their businesses aren't viable, but their finances are far from ideal. Black marks might include erratic cash flow, seasonal business, limited collateral or even poor personal credit.
So, in one sense, online outlets are a godsend, as short-term lenders can satisfy the needs of many small businesses that otherwise are out of luck. Often, the money arrives quickly.
On the opposite side, however, is the increasingly common scenario where online lending creates a vicious cycle for a business by putting them in a debt trap that requires repeat renewals or even new loans, all at potentially crippling interest rates.
Sounds a lot like a payday loan--the scourge of consumer lending -- doesn't it?
That leads to two more questions.
First, will borrowers be able to survive, tolerating expensive debt?
Second, will lenders be able to survive if their clients go belly up? High interest rates can't indefinitely make up loans that aren't fully recovered.
If the answer to both questions is "no," that creates another vicious cycle in the form of a bubble waiting to burst.
Whether that happens remains to be seen, but our best advice to clients is to tread carefully.
If you can do without the loan--even at the risk of missed opportunities--it may be worth it to sit on the sidelines. Or you could reconsider your prospects with the SBA; we talk to clients all the time who think they're not eligible for SBA funding when they really are.
If you can't do without the loan, have an opportunity too good to pass up and are extremely confident of your prospects, working with an online lender might be worth the gamble--with an emphasis on "might."
As for the lenders, it all comes down to greed, as all bubbles do. Those lenders who hand out money at all costs may find their Chapter 11 filings in the same pile as their former clients, while the lenders who practice responsible underwriter will do just fine.
Fortunately, over the past few years we have seen a handful of longer term on-line lenders arrive in the marketplace. If you're looking for a loan on-line they are a good place to start, and they are likely here to stay.