In today’s world of commercial finance, we are experiencing the New Normal in terms of business financing and how businesses acquire capital for growth and expansion. I largely consider myself an advocate of traditional lending through the use of banks and commercial finance companies due to the lower cost of capital. But, due to the way commerce is conducted in today’s world with the use of technology and the fluidity of markets because of increased accessibility provided by the Internet, the need for compatible sources of capital have arrived via the fintech (“financial technology”) boom. Enterprising entrepreneurs have recognized a sizeable opportunity in that a majority of small businesses lack the access to capital needed to grow and sustain their businesses that provide jobs and resources to communities throughout the US. I would have laughed wholeheartedly a decade ago if approached with the business model most marketplace lending sources offer to small businesses now. However, I’m the one that’s being laughed at by these enterprising firms because via creative destruction mainly exacerbated by the Great Recession, they are filling a relevant need in the market both now and for the foreseeable future. I think it’s safe to presume that we’re not in Kansas anymore in terms of the traditional way of providing capital to the small business market via banks and commercial finance companies. I don’t believe that this model will become obsolete, but I do think that it will begin to decrease in scope as marketplace lending takes on more of a relevancy in the market because the way in which commerce is done today is not the same as it was done a decade ago.
Marketplace Lending as a Viable Lending Source for Firms
Business ROI has do with the strategies and decisions a business owner and his / her team make in order to optimize operating profits for the benefit of the firm and its stakeholders. These methods become more acute once business loans are obtained because there’s a requirement to not only repay interest, but also the principal of the loan. The key component of this repayment risk for the business owner is the level and amount of interest charged. Traditional lending sources have been able to provide relatively low-cost business loans, but there’s been a couple major downsides: (1) mostly offered to prime customers that have ideal personal and business credit and (2) abnormally long underwriting and decision times even for prime prospects. What happens to those entrepreneurs that are categorized as mid prime prospects with semi-ideal personal and business credit profiles? Most of these prospective borrowers are left to find other ways and means of meeting business capital challenges primarily credit cards and consumer loans that are not ideal in terms of cost, loan term, and repayment structure. Financial technology firms have come along in today’s market to provide business loans to viable firms that do not fit into a traditional financing sources “credit box”. In other words, there’s flexibility in the structure of the loan product. One downside to marketplace lending is on the high cost of capital due to the Peer 2 Peer model which basically means there’s no middleman between investors and borrowers. In lieu of the benefits that entrepreneurs receive from a marketplace lending source (flexible underwriting and decision structures, fast application and submission platforms, prompt turnaround and access of funds, etc.), the high cost of capital makes sense. In order to minimize the risk of default, business owners must assess the impact the loan will have on increasing and sustaining free cash flow for both repayment and operational growth. Thus, the business and technical risk of effectively using a marketplace loan is with the entrepreneur in that he / she must earn a higher ROI than the interest cost of the loan in addition to the other operating and capital expenses of the business. Welcome to the New Normal.