In a post-recession world, small businesses are still struggling to find funding, particularly in areas hardest hit by recent bank failures. Many are turning to alternative methods—merchant cash advance and factoring, among others—to fill the void left by these so-called “credit deserts” found across the United States.
Industry experts disagree about whether or not a small business lending gap actually exists in the nation; big banks say they aren’t seeing many SMB loan applications, while SMBs say those big banks aren’t approving their requests for capital.
But whether or not that gap exists, the small business lending industry is shifting.
There is data that definitively shows the tightening of big banks’ standards for small business loan approval since 2009, as seen in the Federal Reserve’s Senior Loan Officer Survey. Plus, FDIC data shows that the percentage of loans going to small businesses has declined to about 30 percent in 2012, with small businesses reporting that big bank competition to secure their loan business has taken a nose-dive since 2006.
There is also evidence to support that, lending gap or not, SMBs are turning to new sources for working capital. A recent study by online credit marketplace Biz2Credit found that states with the highest percentage of bank closures had the highest number of businesses seeking loans using the Biz2Credit platform. The four states with the largest number of failed banks—Georgia, Florida, Illinois and California—made up 40 percent of the company’s lending deals arranged between 2009 and 2014. The correlation isn’t surprising considering small community banks are nearly four times more likely to lend to small business than large national ones, according to a Harvard Business School 2014 working paper.
With this expansion of alternative lending choices for SMBs, two noteworthy innovations emerged: the merchant cash advance (MCA), and factoring.
Merchant Cash Advance
Biz2Credit is just one player offering MCAs – the MCA market has seen a robust growth of new players in recent years, including AmeriMerchant and Square, which launched Square Capital last August to allow businesses to borrow a lump sum upfront that is paid back daily through a set percentage of credit card receipts. Speaking to Business Insider, Square spokesperson Faryl Ury said 10,000 merchants used the program in the first three months following its debut in Spring 2014.
With heightened competition, overall interest rates were driven down, and the popularity of the short-term cash infusions helped to combat the stigma that these lenders were the B2B equivalent of a payday loan. Viewed as a trustworthy means to solve short-term cash-flow problems, the market grew quickly.
That success can partly be attributed to alternative lenders arguing they have more to offer SMEs than big banks. Stephen Sheinbaum, president and CEO of Merchant Cash & Capital, another lender offering MCAs, told Forbes the appeal is in the difference from the traditional loan-application process. “Large banks just aren’t nimble enough to do what alternative lenders are doing,” he said. “Most transactions at MCC are funded within hours or days as opposed to weeks or months at a traditional bank.”
Falling outside of the purview of most federal regulations due to their status as non-banking entities, funders interested in exploring MCA still face state-level oversight. In particular, providers must carefully structure agreements to sell, rather than loan, money. Attorney Andrew T. Hayner, writing for The Green Sheet, pointed out that licenses are required for commercial lending in most states, which can be costly. The relative youth of the market means few law suits have directly addressed legal issues related to the MCA industry, though that will probably change with time and maturity, he said, and the market’s continued success and growth is sure to snag greater regulatory attention.
Fueled forward by tighter billing deadlines, SMBs are also turning to factoring to solve cash-flow issues, in which businesses sell their accounts receivable to a third party factor at a discount.
According to players in the industry, factoring is especially helpful to startups without significant assets or a long credit history. Financial specialist and factoring company owner Marco Terry told Factor This last year that through factoring, lines of credit can be written faster, and buyers can more efficiently evaluate the strength of potential clients’ credit before doing business with them.
Factoring has grown into a $3 trillion industry around the globe, according to Factors Chain International. The factoring business model has been largely encouraged by an ongoing late-payment epidemic across the globe – the average number of days a payable is outstanding now tops 40, according to PwC data, meaning suppliers waiting to be paid need to keep their cash flow going, often through factoring services, to survive.
The success of these disruptors brought established players back into the fold in a new way. Wells Fargo, for example, announced its plans to lend $100 billion to American small businesses by 2018, but also secured the acquisition of the factoring portfolio of the Commercial Services Division of GMAC Commercial Finance in 2010. It’s a testament to how the world of big banks changed their tone when they realized now non-banks were solving the needs of SMBs.
MCA and factoring each come with their own sets of speed bumps, but according to small companies in the B2B space, the alternative lending sources are filling the need for SMB capital often unfulfilled by traditional banks.
With buyers and suppliers open to non-traditional funding options, and seeking new ways to manage their cash flow, the space is ripe for those looking to innovate.