How do online business loans work?

Background — an antiquated business loan process

I spent most of my banking career as a commercial lender. Meaning, I helped entrepreneurs get business loans through the various super-regional banks that I worked for at the time. In fact, during the final 5 years of my commercial lending career, I was involved in over $500,000,000 in funding (debt and equity).

That is a lot of funding and that amount of activity led to many lessons.

The biggest lesson I learned was that the process for getting a business loan was antiqued. Up until recently, if you wanted to get a loan from a bank, you had to speak with a commercial loan officer (like me) by phone or in-person. During that conversation, the loan officer asked a bunch of questions to determine if they thought you had a good chance of getting approved. If they did feel positive about your application you moved to the next phase of the process. This included gathering volumes of paperwork. Then you were in the next phase.

A very little amount of technology was involved in moving your application through the loan process.

Like I said, it was (and still is to some degree) an antiqued process. The process is so broken that I have created multiple solutions that address the very pain point of changing how business loans work. The first was an iOS app designed to help entrepreneurs and startups better understand the business loan process. The second solution was a startup I co-founded to help in the leasing space.

The opportunity

Online lenders are fully aware of how broken the business loan process is at traditional lenders and that is why there are so many companies trying to “disrupt” the lending process.

Besides the need for a better solution, there is also plenty of demand for business loans to compete for. To get a sense of the demand for small business loans, let’s look at some Small Business Administration (SBA) statistics. For year-to-date 2017 the SBA alone has funded over $21 billion dollars in business loans. It is that amount of business loan volume that the online lenders want a piece of.

Business Insider states that in 2015 online business lenders originated $5 billion dollars in loans and had 4.3% of the market share. By 2020 those statistics could grow to $52 billion dollars in loans and 20.7% of the market share.

Does different mean better?

One of the ways that online lenders are disrupting the business loan process is through the use of technology to speed up how quickly an application can be taken, underwritten, decisioned and funded. However, part of the gain in speed comes from the use of a completely different type of criteria than what traditional banks use.

Whereas traditional lenders ask for mountains of documentation (personal credit scores, multiple years of tax returns, personal financial statements, bookkeeping records, etc.), many online lenders are merely looking at the owner’s personal credit score, the number of years in business, and the amount of monthly recurring revenue.

Of course, with less information comes more risk for the lender. That is why you may have seen some of the losses that online lenders are seeing. They have approved business loans based on less information and a process that has less of a proven track record.

Are there benefits to using an online lender? There sure are. In fact, in many cases, online lenders are able to move from application to funding a business loan at a quicker pace than traditional lenders. So, what is the trade-off? While many online lenders report having competitive business loan rates, as low as 4.99%, many of the business loans that online lenders make are at a higher interest rate than their traditional lending competitors. For example, I recently saw an article where it was being reported that one particularly popular online business lender had average interest rates exceeding 20%.

One more important note. Many online lenders function as a marketplace. So, when using an online lender you are often able to apply at hundreds of lenders at the same time, rather than talking to one traditional lender at a time. For example, through a relationship I have, I am able to get people seeking funding in front of over 200 lenders at the same time (a mix of traditional and online sources).

So, what?

There is little debate that the traditional business loan process can be very slow and could benefit from the use of technology. However, there is something to be said for having a live person you can work with. But, if you need a business loan quickly and with as little back-and-forth as possible then using an online lender might be right for you.

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