Why Small And New Businesses Should Consider Alternative Financing Sources

Xan Myburgh is the CEO + Co-Founder of Backd Business Fundinga leading alternative financing solution.

In past year, a community bank would have been the obvious first stop for a new business looking to secure financing. Assuming its business plan checked out, a nascent company had a reasonable chance of getting the credit it needed.

Alas, since the crash of 2008, this is no longer the case. For a number of reasons, fewer and fewer banks are willing to lend to small or new businesses. In the last decade alone, there has been a 30% decline in the number of community banks. Meanwhile, the bigger banks are really not interested in clients that require loans in the range of $30,000 up to a couple million dollars; they aren’t incentivized to devote the technology or the human resources to these kinds of small clients, and they can’t justify the fees to allocate to them. This doesn’t mean banks categorically won’t fund these businesses, but it does mean many fewer of them are securing financing.

Moreover, companies fortunate enough to have a bank considering financing them (as opposed to never making it through the front doors) have had to face more intensive scrutiny than they would have had 15 years ago. These businesses will need to present at least a couple of years’ tax returns (effectively disqualifying new businesses, which have not yet had time to obtain this documentation). Those tax returns need to show a decent profit relative to the size of the business. Banks would consider metrics such as revenue growth and decline. If you run a business and you have a year where you didn’t make a profit, that’s a big red flag for a bank. They’re looking at business balance sheets from a long-term perspective and trying to gauge whether a company will still be around in 10 years. This can be incredibly hard to prove—especially if the business is just starting out.

The issue comes down to a fundamental mismatch in interests: Particularly post-2008, banks are worried about taking big risks on businesses that cannot demonstrate sufficient operational history, or merit the resources necessary to oversee such a loan, while new and small businesses cannot gain that history or traction without financing at the start. An August 2020 study showed that only 13.6% of small business loan applications were approved by big banks, and only slightly more (18.5%) by small banks. As a result, a lot of businesses that in the past were traditionally assisted by banks are now left with far fewer options for credit.

Ultimately, in order to survive, businesses must look to other sources of financing. There is a range of products available: Company heads may be familiar with invoice discounting, debt factoring, lines of credit, and business or merchant cash advances. These are all possible options. For sheer accessibility, many businesses are turning to alternative lenders. These are entities that, for various reasons, are willing to offer small or new businesses the funding that banks will not, in much the same fashion.

Sometimes, these arrangements are designed with a direct benefit to the lending entity separate from the terms of the loan. For example, some well-known tech companies offer product financing within their own ecosystem. For example, Amazon and PayPal provide funding to their own suppliers to make sure they can generate fees.

In my experience working with clients to secure financing, I’ve seen that some companies find a benefit in working with dedicated fintech companies who can act as alternative lenders. These smaller lenders can offer shorter-term financing—say, eight to 12 months, instead of the usual three to five years of a bank term loan—and then re-evaluate after that period is up. There is also an emerging class of “buy now, pay later” (BNPL) financing products for B2B lending. And, alternative lenders can often facilitate a smoother process, with much more rapid credit decisions, revolving lines of credit and on-demand funds.

Unfortunately, there are undeniably players in this space that take advantage of companies that cannot secure traditional bank loans, preying on their desperation around procuring capital; small and new companies must be vigilant about red flags and be careful not to get involved with predatory lenders. The good news is that as technology advances, the flow of information and the ability to manage complex casework such as loan applications will also accelerate; as a result, the ability to underwrite and originate loans or advances to these businesses will increase as well. It will become easier to provide companies of all ages and sizes with the capital they need to grow and thrive.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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