Alternative finance, a rapidly growing industry fueled by data technology, investment awareness, and fintech. From innovative loan options and streamlined approvals driven by data analytics, alternative lenders take advantage of technology to meet the underserved needs of small businesses while changing the lending landscape. As incumbent banks pull back from funding small businesses during the financial crisis in 2008, the opportunity to penetrate the lending market presented the rise of fintech altering the lending industry that now is home to both traditional banks and alternative lenders.
While banks have traditional finance models and the power and money to make interest with fewer large corporate multimillion-dollar loans, alternative lenders have the technology bandwidth to process more loans making profitable interest on higher quantities of smaller loans. In today’s lending world it is banks vs. alternative lenders; competitors, yet different by nature creating an environment that has made room for both over the last 10 years.
Technology Driven Competition
Fintech ideation is premised on designing systems processing big data technology to increase efficiency and turn higher profits. The fintech lending industry disrupted long-standing incumbent banks by focusing on this technological innovation to process hard information and better analyze risk. With streamlined data collection and lending underwriting processes, alternative lenders deliver alternative lending models, better acceptance rates, faster loan approvals, and maximum customer satisfaction.
Alternative lenders have higher approval ratings than traditional banks due to their ability to assess more factors than the traditional credit score of historic data on previous loan repayments. High approval ratings are possible thanks to the detailed data alternative lenders can collect and analyze using a combination of algorithms, artificial intelligence (AI), and machine learning to better determine an applicants’ creditworthiness and risk. Fintech lenders use alternative credit scoring to assess applicants’ digital footprint to determine creditworthiness such as rent, utility, and telecom payments, in-depth bank account details and behavior, and social media engagement to gather an accurate picture of integrity and intentions. With the ability to evaluate thousands of data points, alternative lenders are able to capture more segments of smaller businesses that would have otherwise reported a poor traditional credit score. Focusing on current financial discipline, habits, and other interactions provide better accuracy of applicants’ ability, stability, and intent of paying back borrowed funds compared to traditional scoring methods.
Not only do alternative lenders offer loans to small and medium-sized businesses (SMB) who might not otherwise qualify for a commercial bank loan, they offer more financial solutions and a better customer experience. Over 40% of 5,200 retail consumers surveyed from Oracle perceive nonbanks to offer better investment services than a traditional bank. A borrower can quickly upload the relevant documents, statements, pay stubs, and other pertinent documentation to receive pre-approval letters almost instantly in some cases. Fintech’s accelerated lending decisions and fast loan approvals can offer small businesses with funds in a matter of a few weeks or even days.
Traditional banks have not turned a blind eye to the power of streamlined IT processes; to combat competition some have bought non-traditional lending companies, and others have made partnerships with alternative lenders. Most banks have adopted tech capabilities with electronic payment and online services, but innovation is much easier to develop in an IT environment packing in as many possible applications onto one platform. For a large bank, implementing a new core-banking system costs an average of $1 billion. At the end of the day, banks live within different finance and business models than alternative lenders and are chartered by government regulations. Compared to private lenders’ AI data collection, traditional banks cannot become as flexible nor offer a variety of loans to less desired clients while leaving SMB without the financing they need.
The main differences between alternative lenders and institutional lenders
- Finance models: Fintech lenders have perpetually introduced new types of financial models such as peer-to-peer lending, nonbank mortgage loans, and small business alternative loans such as lines of credit, expansion and acquisition financing, invoice factoring, equipment financing, and purchase order financing. With automation, data analysis, and flexible financing options, alternative lenders have established more financial freedom for business owners than conventional banks still currently offer. Banks employ the same traditional workflow model and staffing resources toward analyzing applications regardless of loan size making small business financing a less profitable endeavor.
- Terms and interest rates: Alternative lender’s finance models include short-term loans, which can be useful to businesses even with high-value loans. Typical loan terms for alternative lenders range from 1-3 years while traditional banks usually offer terms of 3-5 years or as high as 10. Alternative lenders being private, less restrictive, and offering more versatile loan solutions translates to higher interest rates than conventional lenders. Rates depend on the alternative lender and type of financing but tend to run higher than banks’ 5-13% ranging APRs.
- Application process: A simplified end-to-end online application process within the alternative lenders’ platform is active which is augmented by automation. This process tends to be far less rigorous than the difficult to obtain documentation, hours of paperwork, and loan processor meetings required from banks. Fintech lenders’ application processes also engineer a much faster turnaround time for approval and finding delivery as mentioned above.
When SMB should choose alternative lenders over traditional
As small to medium businesses are the backbone of the US economy employing nearly 50% of our workforce, access to financing from investors is crucial for business growth. The emergence of alternative lenders has been a positive development in diversifying the lending industry, but it also has opened so many more options for SMBs to assess and choose between. Fintech lending has brought improved access to a broad range of financing solutions, including asset-based financing, hybrid finance structures, alternative forms of debt, and equity instruments. Businesses have the opportunity now not only qualify for funding but also obtain the best-suited financing form and volume to their specific needs.
One of the most obvious and common answers that lead SMBs to seek alternative financing is the immediate need for capital. When a business is faced with an unexpected opportunity that requires quick capital, the power of an online application, automated underwriting process, and accelerated loan approval that fintech lenders offer businesses with quick cash flow, flexibility, and freedom.
Another scenario that may direct a small-medium sized business to an alternative lending solution, is the need to secure a commercial bank loan or larger funding size than their traditional credit metrics pass them for. With many fintech model analyses finding creditworthiness in less conventional activities have the tech-driven capabilities and willingness to fund larger loans than traditional lenders or even ABL facilities when looking at the same qualifications. LQD Business Finance, for example, is a middle-market alternative lender that specializes in large SMB loan sizes of up to $10 million. Businesses that can only obtain a portion of the funding they require from a conventional lending institution will be withheld from following out their business opportunity.
With over 50 financing options in the market today, small businesses should weigh their options, examine terms and rates, and consider their specific finance requirements to determine their best-suited lender and loan type. Alternative lenders are generally more transparent and offer more flexible solutions, but are less regulated, so SMB’s must be analytical when shopping for financing.
Alternative lenders have altered the lending industry and have matched incumbents with small business loans in the marketplace. LQD Business Finance has engineered an in-house proprietary lending structure that utilizes fintech data-driven insights and streamlined underwriting processes to offer transparent, flexible, and customizable financing solutions to underserved businesses today. Apply for a business loan to launch your growth and continue to watch the rise of alternative financing in the continually shifting lending industry.