After years of slow post-recession recovery, things are finally looking up for small businesses. Buoyed by a revitalized economy and positive consumer spending habits, small business optimism recently hit its highest point since 2006. Despite this welcome good news, familiar funding challenges still stand in the way of small business owners' and potential business buyers' plans.
According to recent data from the Federal Reserve Bank of Cleveland, the volume of U.S. bank loans under $1 million (a proxy for small business loans) plummeted between 2008 and 2012--and have yet to bounce back. Small business loans still hover 17% below their pre-recession peak.
With large financial institutions still restricting their small business lending activity, a growing crop of tech startups has emerged to offer owners and acquirers a long overdue alternative.
The growth of data-driven lending
Over the past few years, a handful of young companies has pioneered the concept of online lending marketplaces: branchless institutions that use Big Data to determine any individual or small business applicant's loan value and interest rate. Even in a volatile startup market, these companies are realizing fast success.
Two big names in this space, Lending Club and OnDeck, each had successful IPOs in December 2014 (raising $870 million and $200 million, respectively). Through Lending Club, a peer-to-peer platform focused primarily on personal lending, small business owners can qualify for up to $300,000 loans with one to five-year terms. OnDeck follows a slightly more traditional lending model, offering small business loans between $5,000 and $25,000 for varying terms.
The common thread between Lending Club, OnDeck and other players like Kabbage, CAN Capital and Funding Circle, is technology. Creditworthiness and revenues only reveal so much about a business. But with complex algorithms, alternative lenders can analyze a mountain of applicant information--from social media profiles to Square transaction data--and help more businesses obtain funding. In most cases, these lenders promise almost instant qualification status and access to funds in one or two business days.
Spreading the wealth to acquisition financing
Critics have called out online marketplaces' notably high interest rates (compared to bank loans), but their speed and simplicity alone are pushing alternative lending into the small business mainstream.
Younger business owners in particular have been quick to embrace these startups: a 2014 Bank of America study found that 14% of Millennial business owners had received funding from peer-to-peer networks--in the past year.
Given this success, it's only a matter of time until demand for similar services seeps into the acquisition financing arena. Prospective buyers will always have a need for better access to funding. In fact, lending for an existing business' operations or expansion is common and much more prevalent. Acquisition financing, however, is riskier because when businesses change hands, it is harder to predict the business' trajectory. By building on technology like Lending Club's or OnDeck's--integrating predictive analytics, real-time forecasting, etc.--lenders could determine a potential owner's likelihood of stability and success. Not only would this facilitate more deals, it would also alleviate some of the burden on sellers to finance a significant portion their own transactions.
It's too early to tell who will shake up small business acquisition financing. Whether it's an existing online lender or a new startup, one thing is certain: their audience is ready and waiting.