Published on July 26th, 2013 | by Nik Milanovic0
The Small Business Crowdlending Challenge by Nik Milanovic
Editor’s note: Nik Milanovic is the head of business development & marketing analytics at Endurance Lending Network. He is also a Newfination Expert in crowdlending.
Banking is changing for good. Unlike the sweeping changes and crashes the banking system underwent six years ago, though, this time things are changing for the better. Crowdlending is poised to reform borrowing, fixed-income investing, and consumer savings.
The biggest names in online lending are already well-known. Prosper, On Deck Capital, and Lending Club are racing towards IPOs as companies from Google to Goldman Sachs invest. The success of these first-movers has led to a host of different specialized crowdlenders, in fields from student loans to renewable energy. One of the fastest growing areas in this crowdlending revolution is online small business loans.
Small businesses have typically faced two choices when raising money: sell a stake in the company (equity) or take on debt. Selling part of the company is a high price to pay for relatively little payout – fast-growing businesses can lose out on lots of potential profit by giving away too much for too little. Taking on debt, though, has traditionally been just as unpalatable. Banks are risk-averse and have strict requirements and hurdles to jump for businesses who want to get financed. Alternative lenders charge exorbitant rates in exchange for quick, easy cash.
Now, through crowdlending, small businesses are able to present their requests for funding to groups of investors. Investors can in turn lend money to these businesses at rates they both agree upon. Many small businesses have been able to fund their operations and expansions through crowdlending services quicker and at cheaper rates than with traditional lenders.
Crowdlending makes sense for small businesses for many reasons. Businesses can often get better rates by improving their credit profiles. Crowdlenders also allow small businesses that are otherwise ignored by banks to get funding. Loans from online lenders often take much less time to process than from brick-and-mortar banks, and require much less in the way of applications and documentation. Still, many small businesses go unfunded because they do not know about crowdlending.
Investors similarly miss out on small business lending opportunities. Many are convinced that small business loans do not provide good returns. This misconception comes largely from the performance of personal crowdlenders such as Lending Club: their small business loan category has generated returns on investment of just 0.87% historically (their second-worst category), with a 11.32% default rate.
Yet small business loans are not a dead-end for investors. Funding Circle, in the UK, has proven the viability of making significant returns off business crowdlending, with median returns on investment of 6.8% (meaning that 50% of investors make more than 6.8%.) The key is in figuring out what kind of funding small businesses need, and how to effectively get them those finances from investors.
My company, the Endurance Lending Network, is developing a solution to the problem by making a variety of changes to the traditional crowdlending model. To start, Endurance lends between $25,000 and $500,000 to businesses – the amounts they actually need – whereas most other crowdlenders only lend up to $35,000. Endurance also uses business-based underwriting, not just personal underwriting, to better understand that many businesses are good credits (not just the ones that banks approve.) These methods improve investor yields while minimizing the risk of default, all while providing lower interest rates to small businesses.
By improving the crowdlending environment for small businesses, Endurance hopes to contribute to the changes now revolutionizing the banking industry and provide small businesses across the country with better access to capital.
Crowdlending in general stands to change the way small businesses access capital. By connecting entrepreneurs to savvy investors, crowdlenders can eliminate the middleman and streamline the funding process for smart business owners. This kind of revolution has implications not just for the financial sector but for the whole American economy, where small businesses make up 99.7% of employer firms. We’re excited to see what the future holds.
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