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Behind every small business, there’s a big dream waiting to flourish.
Picture the local bakery crafting mouth-watering pastries, the innovative startup revolutionizing payments, or the cozy bookstore where imagination knows no bounds.
Yet, just like a delicate seed needs nurturing to become a towering oak, these small businesses require a vital ingredient to thrive: easy access to money.
Still, many small businesses find it hard to get access to the finance they need, thereby threatening their ability to invest in growth. No wonder that 38% of small businesses fail due to financial issues, according to CB Insights, a data analytics firm.
In this article, we’ll consider the difficulties of getting small business loans and what small businesses can do.
SMBs and small business loans: The struggle
A 2022 survey by Biz2Credit and reported by Enterprise Apps Today showed that only 14.5% of small business loan applications were approved by big banks. Small banks were only slightly better with a 20.3% approval rating.
Source: Enterprise Apps Today
What are some of the reasons given by banks for these high rejection rates? Let’s consider a few:
- Poor or insufficient credit history: Most small businesses have not had any credit history since they have bootstrapped themselves to where they are. Those that have credit history might have had some poor performance that has led to a poor credit score.
- Limited financial documentation: Most SMBs won’t have the resources to hire a professional accountant. Consequently, bookkeeping may be too basic for what banks require.
- No or insufficient collateral: Many banks will be willing to lend to businesses with poor or insufficient credit history if there is a quality collateral to back (secure) the loan. But most SMBs don’t have the kind of collateral required.
- Poor cash flow: Many banks will also not consider a small business with poor cash flow. Ironically, though, lack of access to funds is the reason why SMBs have poor cash flow.
- Risky industry: Many banks will consider businesses in certain industries (e.g., automotive repairs, trucking, travel agency) as risky and refuse to advance loans to them. Some will only be willing if there is sufficient collateral.
- Supply chain depth: Some SMBs have bigger and more established businesses in their supply chain. However, because they are often too deep in the supply chain, lenders don’t consider the influence of those established businesses when considering loan applications.
SMBs and small business loans: The alternatives
In view of the above, SMBs are turning to certain lending alternatives. While 43% of them applied for a traditional loan in 2019, only 34% did so in 2021, according to data from the Federal Reserve. This “indicates that small businesses are picking alternative financing options, such as crowdfunding, peer-to-peer lending and fintech platforms,” according to Forbes.
Source: Federal Reserve
Let’s consider some of these alternatives:
SBA loans
The Small Business Administration (SBA) helps small businesses to get access to funds by guaranteeing loans made to them by traditional lenders. This government guarantee reduces the lenders’ perception of the riskiness of the loans and makes them more willing to grant them.
There are two types of SBA loans: SBA 7(a) and SBA 504 loans.
SBA 7(a) loans guarantees between 75-85% of the loan and loan amount can be up to $5 million. SBA 504 loans help finance the acquisition of fixed assets for up to $5 million (or $5.5 million in some cases). The lender provides about 50% of the amount while the SBA provides 40%. The remaining 10% must be provided by the borrower.
SBA loans do not require collateral but they will ask for a good credit score, a feasible business plan, and financial records that show that the business is profitable. In the end, they might only be a little bit more accessible than traditional banks.
Crowdfunding
Crowdfunding pulls together a number of investors who contribute funds for small businesses. Platforms such as KickStarter, Patreon, Crowdrise can connect many individual investors and SMBs.
Raising money through crowdfunding requires selling your business plan and pitch and marketing your project so that people can pick interest and contribute their money.
There are two types of crowdfunding based on how investors are rewarded: Equity crowdfunding where investors have a stake in the business and Rewards-based crowdfunding where they are rewarded with non-financial rewards like goods and services.
The cons of this financing method is that you might have to lose a part of your business or spend lots of money giving rewards that will entice investors. Also, you might have to spend a lot of money marketing your project with no guarantee of success.
P2P lending
On P2P lending platforms, investors lend money to businesses on pre-agreed terms that will be enforced by the platform (LendingClub and Prosper are two popular examples). Note that the platform itself does not give loans; rather, they connect people willing to invest their cash with those who need money.
The downside is that you will likely pay a higher interest rate and some extra charges to process the transaction. Some of them will also demand a high credit score to give lenders some assurance.
Online loans
There are various fintech platforms that offer direct loans to SMBs. Most of these platforms are not as stringent as traditional banks but they often charge higher fees and interest rates.
SMBs and small business loans: The way forward
It should be obvious that the difficulty of SMB funding is how to combine accessibility with low cost (fees and interest rates). Traditional lenders (including SBA loans and even crowdfunding) tend to err on accessibility while alternative lenders err on cost.
However, fintechs like Duckfund have been trying to bridge this gap by leaving out stringent requirements like credit reports and scores while charging low financing rates that will not burden SMBs. It’s interesting that Duckfund, for example, has a 60% approval rate for SM loans.
This high approval rate and low interest rate is now the new benchmark for SMB financing and, if done successfully, SMBs can finally get the funds they need to quickly grow.
About Duckfund
Duckfund is a US-based lending platform that helps SMBs access low-cost loans without credit reports or other stringent requirements. SMBs can apply within 60 seconds and get the funds they need within 48 hours. Duckfund’s aim is to help SMBs get fast financing to help them grow without the typical barriers put up by the traditional banking system.
About Author
Anna Kogan is the founder of Duckfund, a US-based lending platform that aims to make financing more accessible to SMBs and commercial property investors.