When online comic book retailer Robert Abendschoen sought a $50,000 loan last year to expand into toys for the holidays, he was turned down by about half a dozen banks. Although his 5-year-old business, SearchLightcomics.com, was profitable, he rented both his apartment and office, and so had no collateral besides his inventory.
Then, Abendschoen saw an ad for Kabbage, a 2-year-old online company that provides cash advances to small businesses. After entering some information on Kabbage's website, he was approved for a $5,000 loan in five minutes. He has since taken out similar-size loans totaling about $50,000, allowing him to expand his inventory and increase his annual revenue by 50 percent to $500,000 this year.
Small businesses, still frustrated by banks' tight lending policies more than three years after the Great Recession ended, are turning to a new crop of alternative lenders that are upending banks' conservative standards and automating loan approvals.
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Instead of stringently relying on collateral and credit scores, these cash-flow lenders are using software that reviews online sales, banking transactions and comments on social-media sites, among hundreds of other criteria, to make loan decisions within minutes instead of weeks or months.
They're providing short-term loans of up to as much as $50,000 to $150,000 to tens of thousands of small businesses that can't qualify for bank loans, supporting a still-weak economy. "They're opening up the market," said Ami Kassar, CEO of MultiFunding, a loan adviser for small businesses.
Yet the loans sometimes come with hefty fees and can carry effective annual interest rates of 20 percent to 60 percent, siphoning cash that small companies otherwise would invest in their businesses, Kassar says. Bank interest rates for similar loans average 4.5 percent to 6 percent.
Many small firms have little choice. Big banks approved 14.8 percent of small-business loan requests in October, down from about 46 percent before the economic downturn, according to Rohit Arora, CEO of Biz2Credit, which connects small firms with lenders of all kinds. Businesses typically must have sufficient collateral, sterling credit scores and strong cash flow to get loans from large banks, Kassar said, tough criteria to meet in the post-recession economy. Many banks find it's not cost-efficient to even review modest-size loans. Approval from small banks is somewhat easier, Kassar said, but only for businesses that qualify for Small Business Administration guarantees. And loan limits on credit cards have been slashed.
There are alternatives. Businesses that don't have enough collateral to get bank loans but sell to other businesses have long turned to factoring companies. They purchase businesses' sales invoices — or accounts receivable — at a discount, providing them instant short-term financing at effective interest rates of about 30 percent. About 12 years ago, merchant cash advance lenders began lending money in exchange for a share of future credit card sales, at effective interest rates of 30 percent to upwards of 100 percent. That helps retailers, for example, that don't have sales invoices.
Cash-flow lenders, which have sprung up the past few years, are funding an even wider pool of very small businesses, including dentists or plumbers that may not accept credit cards. About 65 percent of loans this year to businesses with one to 10 employees are unconventional — including factoring, merchant cash advances and cash-flow lending — up from about 25 percent two years ago, Arora estimates.
Consistent, Focused Businesses
Kabbage's software automatically reviews data such as online sales, bidding histories on eBay, interactions with customers on Facebook and even shipping information from UPS, said CEO Robert Frohwein. Those metrics are important, he said, because borrowers that ship consistent quantities and package weights each day have more focused businesses, making them good credit risks.
"I'm actually getting to know the business better than the bank gets to know Joe that walks in from the street," Frohwein said. Loan default rates are below 2 percent, he says.
Some banks also use computer models to help assess loan applications, but loan officers ultimately make the decisions.
Kabbage borrowers pay 2 percent to 18 percent interest rates for 30-day to six-month loans. Abendschoen has gotten a series of six-month loans at 18 percent interest — an effective rate of 36 percent a year. "I'd rather have a (less-expensive) traditional loan," he said. But he added the cost is more than worth it because he's more than tripled his investment in new toy and comic book inventory.
Late last year, Amazon began providing similar loans, at interest rates of 1 percent to 13 percent, to small merchants on its Marketplace site. The company can assess a wealth of information it keeps about merchants' sales.
Two other relatively new alternative lenders, On Deck and IOU Central, operate like Kabbage by using software to automatically review loan requests within minutes but also serve brick-and-mortar retailers by examining bank transactions, as well as data such as online customer ratings and restaurant health scores. Loans, which average about $30,000, are funded within a day or two and paid back in six to 12 months, with payments deducted daily from a small business' bank accounts. Executives of the two companies say they're in talks to partner with banks, potentially expanding their services to a much larger market.
Rejections From Traditional Banks
Roger Stilson, owner of two Mama Stortini's restaurants in the Seattle area, says several banks wouldn't consider his request for a $50,000 loan to buy a new pizza oven and salad and dessert station to speed order delivery. He says bank officials told him the loan "was way too small…to even think about it."
He obtained the funds about a month ago from IOU Central at an effective interest rate of about 20 percent. He said he expects to increase sales and hire more workers after he installs the equipment early next year.
Bob Sutton, co-owner of CurvyGirls Bridal in Fairfax, Va., was turned down by about a dozen banks for a roughly $175,000 loan he needed for advertising and new product lines. Banks, he says, focused on his lack of collateral, ignoring his unique business strategy of selling larger-size bridal gowns. The store, which opened early last year, isn't yet profitable but is on track to double revenue this year to $1 million, Sutton said.
About five months ago, he got a $75,000 loan from On Deck that he's using to buy new inventory and plans to get additional loans for advertising. After paying an origination fee, his effective interest rate for the 12-month loan was about 19 percent, Sutton says.
"You grit your teeth and take the money where you can get it," he said. "When I needed the money, On Deck was there and nobody else was."