Venture capital firms like small business lending these days, at least the alternative lenders that make pricey capital available to Main Street.
One of the latest examples: CAN Capital, a pioneer of merchant cash advances that just raised $33 million from investors including Silicon Valley stalwart Accel Partners. “CAN Capital was probably the best-kept secret in the emerging financial innovation boom,” says Accel general partner Kevin Efrusy in a press release. There isn’t much on how CAN plans to spend the money, but presumably the new funding will further its “mission of helping small businesses obtain faster and easier access to capital.”
To judge by a long article in the Wall Street Journal this week, alternative finance companies are doing a good job when it comes to “faster and easier.” The paper reported that about two-dozen nonbank lenders including CAN Capital, OnDeck, and Kabbage (those latter two also have high-profile venture capital backers), provided $3 billion in financing last year. That’s about double what they lent in 2012, and one-tenth the amount in loans backed by the Small Business Administration in 2013.
Despite the increase, the alternative finance market hasn’t changed much since my colleague John Tozzi wrote about the rise of merchant cash advance providers in 2009. The basic proposition: Banks don’t see much to gain by making loans for the small amounts many Main Street businesses require. Alternative lenders use computer algorithms to turn around loan applications in days or hours, using social media and other nontraditional data to examine businesses with weak credit profiles. Faster and easier comes at a cost: The Journal says rates at alternative financiers can top 50 percent on an annualized basis.
Nonbank lenders usually explain the high costs as the price of admission for financing that you can’t get at banks, and many alternative finance companies decline to comment on their average annualized interest rates, arguing that APRs would invite imperfect comparisons. (CAN Capital didn’t respond to a request for its borrowers’ average costs.) It should also be said that expensive is relative to how business owners use the capital. Borrowing at 50 percent APR to make payroll is just putting off the inevitable; using the money to buy a piece of equipment to help boost profits might make sense.
There’s reason to hope that nonbank loans will get cheaper. As the alternative lenders build volumes and track records, they may access cheaper credit themselves, and pass on savings to their customers. Peer-to-peer lending for small business loans promises a source of nonbank loans at lower rates. A recent article in American Banker (subscription required) suggests community banks are increasingly willing to partner with alternative lenders that are transparent on borrowing costs.
For many small business owners, accessible finance at affordable rates would be the real innovation.