By many accounts, small businesses appear to be faring well in 2016, despite the global economic slowdown.

But one sector that's running into choppy water is online lending, an industry that grew out of the financial crisis and now comprises about 200 providers offering credit to small business owners and consumers. Many of these companies, which include Inc. 5000 companies OnDeck Capital and Lending Club, are startups themselves. 

On Monday, OnDeck suggested in its fourth quarter earnings statement and call with investors that its 2016 revenues were likely to grow at a rate about five percentage points lower than the consensus forecast. That sent the company's shares skidding nearly 25 percent by midday Friday. Competitor Lending Club was also caught up in the rout, with its shares falling nearly 8 percent over the same time period.

Online lending still includes some less-than-savory competitors that experts often compare to payday lenders because the annual percentage rates of their loans can exceed 50 percent. OnDeck and Lending Club are considered standouts, however, and their recent fortunes mark a dramatic turnaround for a nascent industry that as late as last year appeared very promising to investors.

When OnDeck went public in 2014, its stock price soared as it offered to revolutionize small business lending by quickly granting credit via the Internet to companies that traditional banks had trouble servicing. Lending Club has similarly attempted to make credit more democratic, providing small business loans by matching entrepreneurs directly with individual or institutional lenders online.

"Alternative lending has gone mainstream," Noah Breslow, OnDeck's chief executive told this reporter in March of last year. "Our goal in the next five years is to become the leading small-business lender in the U.S., period."

(Executives from OnDeck and Lending Club were unavailable to comment by deadline.)

The crowded field of alternative lenders may be due for a shakeout, lending experts say. That's because these companies, whose industry came to life during the financial crisis when banks all but stopped lending to small business owners, have not been tested during a down cycle.

Most alternative lenders have promised to make fast, smart decisions based on newfangled credit scores that analyze big, unstructured data sets. Some claim to examine items like rent payment histories or a potential borrower's social footprint to get an indication of risk. But the reliability of those credit scores will be tested as economic conditions become more challenging for business owners, which could be on the horizon, experts said.

"Lending Club and OnDeck and CAN Capital are among the stronger players, and they are backed well by VCs, and they have the money to acquire data scientists for risk management," said David O'Connell, a senior analyst at financial services research firm Aite Group.

At the same time, scores of other, less-well-known companies may be extending credit without proper risk assessment, O'Connell adds. And that could mean those companies could wind up with an increasing number of defaults on their books, while business owners may take higher interest loans than they need to. It could also mean businesses are getting loans that they shouldn't be eligible for in the first place. 

The net outcome is likely to be a consolidation in the industry in the year ahead, as some of the weaker online lending companies fold, experts said. In turn, that may make their high-interest loans more difficult for small businesses to come by.

In the short run that may create an unfortunate climate for some small business owners who are desperate for credit. Longer-term, however, it is likely to be a positive development for entrepreneurs.

"Small businesses should do their best to establish direct relationships with either local community banks, regional players, or top-tier financial institutions, depending upon their business type," says Brian Riley, a principal executive adviser for CEB TowerGroup. The payoff is likely to be much cheaper credit, and from an institution that is more subject to federal lending requirements.

Published on: Feb 26, 2016