Looking Beyond Alternative Lenders For Startup Financing

Post-financial crisis, FinTech shed light on the plight of small and medium-sized businesses (SMBs) seeking capital, often shunned by banks — thanks to a lower risk appetite and more stringent regulations.

However, if SMBs’ access to capital is small, startups’ struggle to gain financing is even narrower if an entrepreneur decides to not sell a portion of the company in return for venture capital. Higher risk profiles and a near-nonexistent credit history mean that banks, and often alternative lenders, won’t lend to a startup, which can force business owners to borrow money from friends and family, or rely on personal credit cards to stay in operation.

The capital concerns of a startup owner, though, are often the same as those of an SMB owner: How to keep the lights on and make payroll are no less concerning to a young startup. Yet, the underwriting concerns among lenders are real, considering that as much as 90 percent of startups fail, according to Startup Genome analysis, with separate research finding it takes years for a startup to become profitable.

BJ Lackland, CEO of Lighter Capital, spoke with PYMNTS about the biggest challenges for both startups and lenders in addressing the financing gap, as well as the unique strategies the industry can deploy in its effort. According to Lackland, angel investors and venture capitalists are often the only options for startups in need of financing to grow.

“That’s really it,” he said. “There aren’t many alternatives” besides factoring or merchant cash advances, both of which can carry a “stigma,” not to mention high interest rates.

To be fair, Lackland noted that Lighter Capital’s financing for startups isn’t necessarily cheap, with interest rates at about 15 percent to 20 percent. However, the firm recently announced the introduction of two additional financing products, its Term Loan and Line of Credit, allowing startups to draw down credit and only pay for the credit they access, according to Lackland.

The most strategic way to make financing affordable, though, is to mitigate risk as much as possible, which isn’t necessarily easy when a young company lacks a credit profile. For tech and Software-as-a-Service (SaaS) startups, it can be even more difficult, Lackland noted, because traditional lenders often don’t understand their businesses, and the startups are operating without any hard assets. Plus, these companies are in their cash-flow-negative phase.

This is where data analytics comes into play.

“Banks look at historical data only,” he said. “They say, ‘You’re losing money. I can’t give you a loan.'”

While traditional lending requires a look at historical financials, addressing the capital gap for startups requires a forward-looking approach, as well as an exploration of non-traditional data. Data science and forecasting technologies have made it possible to aggregate thousands of data points — including financial information within accounting platforms and Excel spreadsheets, as well as information from platforms like LinkedIn — to underwrite loans.

LinkedIn is particularly helpful in understanding the profile of a business owner, and in validating a company for fraud purposes, said Lackland. For SaaS startups, accessing data on customer contracts and term rates — as well as analyzing the lifetime value of a customer, customer acquisition costs and other metrics — enables a predictive view of if and when a startup will ultimately become profitable.

“We can know so much about how [an] SaaS startup will operate and grow,” he explained. “We take data, and project it going forward.”

While it may not be profitable for a bank to undertake this underwriting strategy to finance startups independently, Lackland noted that there is indeed opportunity in FinTech firms like Lighter Capital collaborating with traditional banks — though not necessarily in the same way that banks have begun working with alternative lenders as of late.

Earlier this year, Lighter Capital announced a collaboration with Silicon Vally Bank to connect startup owners with a range of financial resources, including capital and banking services. Rather than a traditional bank integrating an alternative lender’s technology platform, the firms are working together to provide a more holistic financial service experience for startups. These tie-ups, said Lackland, can promote a seamless growth trajectory for companies that, as they grow, can more easily transition into the financing services of a larger bank — even if they may not be the right fit in their earliest stages.

“Startups are really attractive future clients to lots of different banks,” he stated.