Since the financial crisis of 2008, it's been harder for small businesses to get the money they need to operate or grow from traditional lenders. There are several reasons -- starting with the fact that bigger loans mean bigger returns for the same amount of paperwork. Lending to a small business is also riskier, and banks have learned to be risk averse since the Great Recession, according to a 2014 Harvard Business School working paper, "The State of Small Business Lending."
But now business owners can turn to online lenders. Online loans often have higher interest rates than traditional small-business loans, but they also offer two advantages: They can deliver funds quicker than banks or credit unions, often in a few days or weeks rather than months. They also may have less stringent requirements, although the criteria may include unconventional factors a traditional lender would never consider, such as a business' online reviews or social media connections. Some online lenders, such as Fundation, provide loans directly while others, such as Lending Club, connect business owners to individual or institutional investors.
What factors do online lenders consider?
Most lenders use a similar set of criteria when reviewing applications. Loan terms, and whether a loan is offered at all, can be decided by:
Revenue.There may be a monthly or annual minimum.
Years in business.Many lenders offer loans only to businesses that are at least one or two years old.
Industry.Some businesses are riskier than others. It can be particularly difficult for a new restaurant to secure a loan, for instance.
The owner's personal credit.Although there is a separate business credit scoring system, most lenders examine a small-business owner's personal credit. Generally, a small-business loan requires a personal guarantee from the business owner, meaning the owner's personal assets may be seized by the lender if the debt is not repaid.
A business plan.The lender wants to know what the business does and where it is going. A business plan should have a description of the business' services or products, share how it is meeting customers' needs, and give a roadmap for the future with projected financials.
Business owners may need to share personal and business tax returns and the business' financial statements. Some online lenders work only in certain states.
Types of loans for small businesses.
Before seeking a loan, consider what type of funding is appropriate. There are many different types to choose from, but the basic two available from online lenders are:
A term loan.Like an auto or personal loan, a term loan offers a lump sum of money that must be repaid in installments over a period, or term -- often two to five years. Term loans may either be unsecured, given based just on the borrower's credit, or secured by assets such as business equipment, property, or savings.
A line of credit.Companies with a line of credit can withdraw money from an account when they need it. Interest is charged on the amount taken. When the equivalent of the total line of credit is borrowed, a business owner needing more money will have to apply for another one. A revolving line of credit can be drawn from over and over as long as the money is repaid -- like a credit card.
Businesses can also secure funding using invoices as collateral. It's typical to get about three-quarters of the invoice amount from a lender, with the rest coming minus a fee when the invoice is paid.
Another alternative is a merchant cash advance, in which a business borrows in exchange for a cut of its sales in the coming weeks or months. This technically is not a loan but rather a sale of future income. This loophole lets MCA providers charge the equivalent of triple-digit interest rates, which is why an MCA is a last resort in most cases.
Comparing online loan offers.
There are so many online lenders to compare that business owners can get overwhelmed. Save time and find the best deal by comparing different loan options with an online small-business loan marketplace.
After asking business owners to share a financial profile, online matchmakers including Fundera, Lendio, Biz2Credit, BoeFly, and CNF Exchange present potential lenders and make it easy to compare terms. (Marketplaces don't work with every lender, so it may be best to compare options using several at once.) Depending on the marketplace, either the lender or borrower may have to pay a fee before the loan is disbursed. But the initial process is free, and often takes less than 10 minutes.
Before agreeing to a loan, be sure to read the fine print and calculate the true cost. Often, lenders will charge additional fees or list the dollar amount that needs to be repaid as opposed to the interest rate on the loan, and that can make comparing the real cost between lenders difficult. There are handy calculators for comparing the cost of different types of loans on Fundastic, an educational resources and loan marketplace for small businesses.