There are 5.7 million small businesses in this country, according to 2011 US Census Data, and at some point most of them will need loans to fund expansions or supplement sporadic cash flow. Increasingly, those businesses are turning to online startups for financing, paying higher rates for the convenience of qualifying quickly and easily for the loans.
How credit unions view these lending upstarts varies. Some like Kenneth Plank, chief lending officer with Numerica Credit Union (Spokane, WA, $1.3B) where member business lending constitutes 19.4% of the portfolio, see the newcomers as a long-term threat.
“As their balance sheets get stronger, they are going to look for ways to get a bigger slice of the pie,” Plank says.
Other credit union executives have a more positive assessment.
“Competition is good for our industry. It keeps us on our toes, forcing us to be efficient,” says Richard Mullen, senior vice president and chief lending officer of Coastal Federal Credit Union (Raleigh, NC, $2.2B), which has nearly 14% of its portfolio in member business loans.
Mullen believes online business lenders can offer credit unions new ideas for refining their own lending products and processes. Some of those lenders may even be suitable vendors to partner with in future, he says. Either way, the three online lenders described here bear watching because they’ve found a marketplace niche and satisfied a need that wasn’t being met.
Linking Payments To Credit Card Sales
Best-known for a card reader that lets businesses accept payments from a mobile device, Square introduced a new service, Square Capital, in May to provide cash advances to the two million businesses that use the Square reader.
“Independent businesses are often forced to spend months filling out massive amounts of paperwork and navigating complicated application processes,” Square spokesperson Faryl Ury writes in an email. The Capital program simplifies the process, providing access to cash as quickly as the next day. So far, Ury says the company has advanced “tens of millions of dollars” to thousands of businesses.
Borrowers request the amount of the cash advance and are eligible based in part on the business’s volume of sales made using the reader, though Square is vague about other requirements. In exchange for the cash advance, Square adds a flat 10% fee. So, for example, a business with a $10,000 advance would repay Square a total of $11,000 from future card receipts. In lieu of traditional, monthly interest payments, borrowers repay the advance and fee by giving 10% of their daily credit card receipts to Square.
“There is no set time period for them to pay,” Ury says. “They pay more when business is strong and less if things slow down.”
That’s an attractive feature for borrowers who can adjust their payments depending on the strength of their sales. Still, the flat fee offers no incentive to borrowers to repay the advance more quickly, and there is another cost to consider. The speedy process, Plank says, sacrifices getting to know the borrowers to ensure that they are getting the right loan for their needs.
Extending Short-Term Lines Of Credit
Named after slang for money, Kabbage (https://www.kabbage.com/) offers businesses a line of credit ranging from $500 to $50,000 that can be drawn on multiple times a year, but the money must be repaid within six months. Borrowers typically use the line of credit seven times a year for an average loan size of $5,000, according to Victoria Treyger, Kabbage’s chief marketing officer. Since it began three years ago, Kabbage has extended more than $350 million to small businesses.
Kabbage differentiates itself from traditional lenders with faster automated underwriting that evaluates financial data conventional lenders usually don’t consider. In addition to the business owner’s personal financial details, such as a credit score, and a business bank account, Kabbage also asks borrowers to provide information about the business’s other financial accounts, including Square and PayPal. They present a more complete picture of the business’s finances, enabling Kabbage to offer a line of credit in as little as seven minutes, though many customer testimonials on the company’s site claimed longer periods of up to an hour.
The money is transferred automatically into either a PayPal or business checking account, available for use instantly. Kabbage even has its own mobile app so that borrowers can access the account on the go. Individuals can draw from the funds once every 24 hours, paying only for the money they take.
Kabbage structures the repayment program over six months, with one-sixth of the total amount paid monthly, though the money can be repaid sooner. In addition, Kabbage collects a fee between 1% and 13.5% of the amount borrowed for the first two months and 1% thereafter. Unlike Square, the payments aren’t drawn from daily revenue. Nor does the loan drag out, and the payment structure gives businesses a set amount to be repaid monthly that they can plan for in advance.
The high rates and low dollar amounts strike Stephen Mackowitz, senior vice president of commercial lending at Digital Federal Credit Union (Marlborough, MA, $5.6B), as a static business model posing little threat to cooperatives.
“The loans they’re doing we probably wouldn’t do anyway,” says Mackowitz, whose credit union has 12.7% of its portfolio in member business loans. But he is also skeptical about the online lenders’ staying power.
“I’ve been in commercial lending for over 30 years, and I’ve never seen anybody be a permanent success in small business lending,” he says. Some earlier startups like the Money Store, which specialized in SBA loans, aren’t even around any more.
That could be why in addition to offering lines of credit Kabbage wants to position the company as a resource to financial institutions looking for additional data about a small business borrower. The company is currently in discussions with banks and credit unions to license its data platform.
Connecting Borrowers With Lenders
Originally founded in the UK, Funding Circle crossed the pond in October 2013 to bring its peer-to-peer lending network to the states. The company matches borrowers to individuals and institutions lending up to $500,000. To date, Funding Circle has loaned $525 million to small businesses and expects to lend $100 million in the United States this year, The average loan Funding Circle of $140,000 according to Albert Periu, director of capital markets.
The company also touts the fastest loan approval times, claiming it takes just 60 seconds to determine eligibility and less than 10 minutes for a borrower to complete the online application if no additional paperwork is needed.
“We can be more flexible, thoughtful, and responsive than a bank,” Funding Circle writes on its website.
Loans are for three to five years and have fixed monthly payments, with interest rates based on cash flow, credit scores, and even online reviews of the business. Those the rates can be as much as 24.99% after factoring in an origination fee of 2.99%. Late payments are hit with a fee equal to 10% of the missed payment.
Those rates are reassuring to cooperatives fearing the startups will take away business. With figures like that, a credit union’s market share for small business lending is hardly under siege because compared to the 5% to 7% rates Numerica charges members for the loans, Funding Circle’s are downright punitive.