Schooling SMEs, And Regulators, On Alt-Lending Tech

Members of the FinTech world may be well-aware of the alternative small business lending explosion. But, according to SME lending platforms Dealstruck and Lendio, a significant knowledge gap remains for small businesses struggling to find working capital.

The two businesses recently teamed up to release an eBook, “Small Business Lending in the Digital Age,” in an effort to outline for small business owners exactly what’s going on with the lending sector and how they can take advantage of new services when a bank falls short.

“We created this eBook to help shed some light on why banks have shied away from smaller loans in recent years,” said Dealstruck CEO Ethan Senturia in a statement at the eBook’s release, “and to show how the online industry has grown to fill the gap.”

The eBook throws out some pretty startling figures about the small business lending sector. Namely, that traditional banks are more interested today in providing loans in excess of $1 million, yet the majority of SMEs are looking to borrow $250,000 or less.

That disconnect has generated a $550 billion gap in small business lending in the U.S., the companies said. And while alternative lenders have rushed in to fill that gap, the number of players and the types of loans they can offer small businesses can be dizzying. On top of that, the industry has developed without much regulation, and policymakers are just beginning to eye the sector, which could further complicate its development.

PYMNTS wanted to learn more about how alternative lending players like Dealstruck and Lendio are working to fill the knowledge gap for small business borrowers in such a complex market ecosystem. We spoke with Dealstruck’s Senturia to fill us in.

PYMNTS: This conversation has been going on for a while now. What was your ultimate goal in publishing this eBook?

ES: The ultimate goal for us was continuing to provide education to the market and build awareness of alternative lending. In the last few years, there has been a proliferation of options, different products, different players, and it’s hard for small business owners to try to separate news from noise. One of the things that we take very seriously at Dealstruck is being transparent and trying to provide a level of education to our perspective and existing customers so they understand what their business needs, what’s best for them. We try to figure out a way we can serve them, but if there are other places that would be a better fit, we want to make business owners aware of them so they can ultimately have more success. So, this is nothing more than trying to continue to put more education out there and to make it relatively easy to digest all of what is going on right now, which is a lot.

PYMNTS: The small biz lending space is really complex. There are dozens of loan products for small businesses, and yet what I’m hearing from several players is that small businesses don’t necessarily know all of their options and education is key. What are some of the challenges for small business owners in terms of figuring out not only where they can access a loan but what type of loan they need?

ES: One of the ways to figure out what you need is to try to partner with a lender who has the ability to deliver multiple products. For instance, at Dealstruck, we do AR financing, inventory financing and we do term loans, and if you’re a business owner, we are able to understand your needs and deliver a product that’s suited to it. Whereas if you go to a player who only has one trick, so to speak, then no matter what is the right solution for your business, they’re going to try to sell you the solution that they have. That’s one of the things you can look for as a business owner: who has multiple products and who can actually meaningfully respond to how my business needs may be different than the business that came before me or the business that comes after.

Another piece is to be more proactive, take your time and forecast your capital needs somewhat in advance. Then, you can go out and do your research and look at review sites. That way you have time to make an informed decision. A lot of times, business owners’ working capital needs sneak up on them, and that’s when it can be difficult to really put the time or energy into understanding the right decisions for your business, because you simply have to act quickly.

[bctt tweet=”A lot of times, business owners’ working capital needs sneak up on them.”]

PYMNTS: The eBook mentions that a lot of the alternative lending marketplaces and players in the space are trying to be proactive when it comes to regulation, implementing best practices before they’re even required by law. But it also mentions that some players are taking advantage of a lack of regulation in the space. Can you expand on that? What shady practices have you witnessed in this space?

ES: Transparency is a big thing. There are players out there who obfuscate what the true cost of their financing is by pricing them not on an APR basis or interest rate basis but instead using some other, non-standard pricing methodology, like factor rates or buy rates.

Pricing transparency is a big one. Sometimes, lenders will market that they have a no prepayment penalty, when in fact their product’s structure includes make-whole penalty on a prepay. They’ll market and say, “We don’t have a prepayment penalty.” But you’ll actually end up paying a larger cost if you prepay than someone who does have a prepayment penalty.

There are owners’ exit clauses. Sometimes, there are certain alternative lenders that have agreements that are very difficult to get out of. When you go to refinance into a better or cheaper or larger product and sort of graduate, all of a sudden you find out there is a big fee to get out of the original loan product or you can only get out of it during certain days or months of the year.

Those are things where, at first glance, a business owner might say, “Well, it sounds like I’m getting the amount of money I need when in need it.” But once you’re in the product, that is when you realize, “Oh shoot, this is a bigger drain on my cash flow than I would initially anticipate.” Or, “Wow, I was planning to refinance out of this after I grew for six months, but there’s a big fee to get out of it.” Those are some of the key things that are really not consumer- or borrower-friendly. As an industry that’s growing and starting to get the eyes of some regulatory agencies or government agencies that want to learn more about it, those are the practices that we would be better off reaching ourselves in advance, rather than waiting for some outside mandate to come down.

[bctt tweet=”There are certain alt-lenders that have agreements that are very difficult to get out of.”]

Right now, government officials want to learn more about the industry and seem to be taking a softer, more passive approach to the alternative lending space. Do you think that will change? What will be some of the first actions made by authorities when it comes to implementing regulation?

ES: One of the things that is not exactly synonymous with alternative lending but it’s a very close sibling, if you will, is technology. A lot of the alternative lenders are technology-enabled and are financial technology companies. I think what you see is not just a financial shift in terms of where the capital is coming from, through more communal alternative lenders versus traditional banks and credit unions, but it’s also a shift in the system, and the data and the methodology that’s used to deliver the product.

One of the things regulators understand is that when new technologies are emerging in a market, if your regulation is overbearing or too restrictive, then you may actually cut off the benefits that come from that innovation before it has a chance to mature. We’re really appreciative that the Treasury, which isn’t a regulatory agency but certainly has high influence, is taking an approach of really trying to learn as much as possible about this industry before making any recommendations or publishing any big whitepapers. How this lending is being done is quite nuanced, and putting thoughtful regulation in place to make sure the industry is healthy and safe for the borrowers and business owners and consumers is a good thing. But the approach of treading lightly to make sure they have complete information and that whatever they do is being done in conjunction with participation of the industry is a good idea.

Do you think that has anything to do with the idea that banks have retreated from small business lending? Many banks cite more stringent regulation as a reason they’ve been forced to reduce small business lending, as they don’t want to take on the risk. Will authorities recognize that banks have to adhere to stringent rules and see an opportunity for alternative players to have a bit more relaxed guidelines?

ES: I think that’s right, and I think that’s part of why their approach has been very thoughtful and collaborative with the industry. There has been a very measured approach to how they’re learning about the industry, because they have invested interest at the macroeconomic, national level of making sure these businesses have access to capital. And they’re not getting it from banks. They need to get it somewhere else, and you have to make sure that that somewhere else doesn’t get cut off by regulation or by an agency coming in and trying to make rules without fully understanding it. We really appreciate how thoughtful the government agencies have been in trying to learn from us.