15 years ago we booked trips with offline travel agents. Today we use sites like Kayak and Expedia to shop for our best options and rates.
5 years ago we were hailing cabs with our hands waving in the rain. Now we touch a button on our smartphone and an Uber arrives in minutes.
Today, if a small business owner wants a loan, they search for a bank that can accommodate them, and still, 82% will be told "no." Within the next 5 years however, there will be only one place they need to look: online.
Just as technology has transformed how we shop and travel, "alternative" or "non-bank lending" will soon no longer be considered "alternative". It will simply be lending--it will be the norm. As more people turn toward their laptops and phones over brick-and-mortar retail, lending and financial services have stepped up to the plate to build secure alternatives to highly regulated bank transactions. They are ready to play ball against traditional financial institutions.
Alternative lending emerged in the wake of the financial crisis and banks' tightening of credit standards. As bank loans to small businesses continue to decline, access to new types of loans has strengthened. Alternative lenders will soon be the primary providers of credit to small businesses and their dominance will be asserted through their ability to use technology to streamline the process across these four bases of innovation:
1. Customer Experience. The process of applying for a bank loan is painful. Studies have demonstrated that the average loan application can take anywhere from 48-72 hours to complete. That's two to three days of non-stop workassembling paperwork. All of that effort is met by a rejection rate ranging from 50-80%, depending on the institution.
As web-first companies, alternative lenders have grown to provide customers with the efficiency they want and deserve. Instead of 72 hours of paperwork, completing an application takes only minutes. Instead of pen and paper, modern web and mobile interfaces reduce the approval turnaround time from 3 months to 3 days, and in some cases 3 minutes. In instances where customers want to evaluate all of their options and compare prices in one place, small business owners can now turn to sites like Fundera or QuickBooks Financing for a convenient, thorough, one-stop shop experience.
2. Underwriting. Underwriting is the process a lender uses to evaluate a borrower and decide if they are going to offer them a loan. Generally, underwriting consists of evaluating bank statements, tax returns, balance sheets, P&L statements, and credit reports with a pen, pencil, calculator, and spreadsheet. A final decision is often made after visiting the borrower's place of business. This antiquated process won't last forever.
Alternative lending applies new, more scalable underwriting practices that enable non-bank lenders to widen their scope of customers. Instead of evaluating bank statements and tax returns, lenders like Fundbox and Bluevine underwrite customers simply by evaluating their QuickBooks, Xero, or FreshBooks data. Companies like PayPal and Square can proactively extend credit offers to their customers by analyzing patterns in their cash flow. Positioned in the middle of every transaction, these companies assume less risk on the repayment side. Services like Intuit Account Aggregation, Yodlee, and even an API the IRS has made public all accelerate the time to underwrite and help democratize access to actionable data. The future of underwriting will be as simple as a customer authorizing access to these online tools and receiving a response in minutes.
3. Cost of Capital. While banks are hands down the cheapest source of credit available to small business owners,banks aren't making many loans to small businesses these days relative to before the financial crisis. Why? They are considered a riskier asset class and loans are made with the deposits of retail investors and customers whose money the banks must keep safe.
The difficulty in obtaining bank loans led to the rise in alternative lending, and it won't be long before these non-bank lenders can compete with the banks on price. Popularized by Lending Club and Prosper in consumer lending, and implemented by Funding Circle and Dealstruck on the small business credit side, transactional marketplaces are innovating their cost structure and, as a result, delivering lower rates to customers.
Instead of holding the loans on their balance sheets, they are managing capital for institutional and accredited investors and enabling them to invest directly in small business debt, acting more as a platform than a lender. These companies, simply perform the underwriting and servicing of the loan, and make money off origination and servicing fees. This unique capital structure has helped to drive down prices for customers and make less expensive, longer-term loans more accessible.
4. Customer Acquisition. Alternative lenders' ability topiggyback off established platforms and integrate with services like QuickBooks, Xero, eBay, Amazon, and Etsy, enable them reach new customers. Similarly, lenders are getting smarter about finding customers by using databases like Radius to market to highly targeted audiences.
A few years ago, if I wanted a loan to expand my flower shop and there were 3 banks and 1 credit union in my small town in Connecticut, I would visit each of them to see who would give me a loan--and at the best price. If all of those providers said no, I'd have no options. Today, finding a loan is as simple as seeing an ad for a lender on Facebook or Google, spending less than 20 minutes applying, and being presented loan options within minutes, hours, or a few days. The systemic shift away from physical retailers to online platforms substantially increase my chances of not only finding a loan, but finding the lowest-cost loan with the best-possible terms, in a fraction of the time.
I used to say alternative lending was still in its first inning, but it's now rapidly moving into the second or even third, making it a whole new ballgame. With Lending Club and OnDeck's IPOs, it's clear alternative lending is hitting its stride against traditional financial institutions, and touching all the bases of innovation. This game will only get more exciting, especially for small business owners.