Credit needs of small businesses vary significantly and, while there is no comprehensive data to measure them directly, various proxies can help identify trends.
Current business financing conditions remain favorable, while interest rates have seen an uptick from historically low levels. Meanwhile, new lenders and products offer alternative sources of funding for small to midsized enterprises (SMEs).
Online Lending Alternatives
There are various alternative funding sources for small businesses besides traditional business loans that may help secure funds, including presales of services or products, using personal savings, selling assets or taking out lines of credit as well as crowdfunding platforms such as Kickstarter and GoFundMe. While these methods can provide funds quickly for business use, they may lead to an endless cycle of borrowing which limits how much a company can save and invest.
Although data are limited, indicators suggest that financing flows to small firms grew more slowly during the pandemic. Loan and line of credit applicants decreased, while trade credit, merchant cash advances, factoring and factoring rates either held steady or increased (see figure C). Participants noted that local programs, including CDFIs and fintech-enabled online lenders/brokers provided more information regarding federal assistance programs than did national organizations and their members (see figure D).
Crowdfunding disrupts the traditional business financing model: rather than pitching your product or service to just a handful of investors, you put it directly in front of thousands of potential customers and put yourself out there for investment by way of crowdfunding.
Rewards-based crowdfunding is one of the more prevalent approaches, with backers contributing money in exchange for products or services from your project. Equity crowdfunding also allows companies to raise capital via selling a piece of their company to backers in return for funds.
Financial institutions providing business loans to small firms often rely on relationships with local businesses in order to offer long-term loan programs known as relationship lending. While this type of long-term lending may increase credit available over time for these small firms, its flexibility may limit them from tailoring their loans exactly according to each business’ needs (See Box 1).
P2P lending has rapidly emerged as an attractive option for small business financing in recent years. P2P lenders connect borrowers and investors, often at rates lower than what banks can provide, to fund loans at competitive interest rates. Peer-to-peer loans also tend to be less risky than equity financing solutions which involve selling ownership stakes of your company in exchange for funding.
Borrowers must remember that peer-to-peer (P2P) lenders may not follow the same regulations or provide as many protections, so before making their loan decision they must always carefully consider all terms.
P2P loans may seem complicated at first glance, but their application process is generally simpler and faster than applying for conventional bank loans. Borrowers can focus more on their business’ health and cash flow rather than credit scores when applying – making this solution suitable even for businesses with poor credit profiles.
Small businesses usually obtain credit from traditional lenders like commercial banks and credit unions, who offer an array of business financing products like working capital loans, lines of credit and equipment or commercial real estate loans. Traditional lenders tend to offer lower interest rates than alternative lenders; however, approval criteria can sometimes be stringent.
Some small business owners prefer the personalized service provided by local banks and their ability to meet all their financial needs in one location – including savings accounts and checking accounts as well as credit cards – with one institution. Furthermore, such banks may partner with organizations offering packaged financial resources from various public and private sources for small businesses.
Examples of such programs are offered through the Small Business Administration’s 7(a) loan program and state economic development agencies’ business finance initiatives, while large banking organizations support high-growth companies with reliable cash flow and good credit scores.