Even the most innovative ideas for a new business require money to get them out of the garage and onto the path to profitability. Getting necessary funds is rarely easy for startups. Entrepreneurs will often tap their personal savings and credit, even borrowing money against the equity in their home or other assets. That approach may suffice initially, but unless you can begin to turn a profit early on — something most startups struggle with — you’ll likely have to seek outside financing.
A strong business plan and vision may win you financial support from venture capitalists, though it will cost you a slice of the equity in your business. The same goes for using a crowdfunding campaign to raise money. If you’re not quite ready to give up shares of your business, you can try applying for a small business loan from a traditional financial institution. The odds of getting approved as a startup aren’t great, however.
The Current Lending Landscape
Some 63% of startups that applied for a loan of $250,000 or less did not get what they sought, according to the Federal Reserve’s 2019 small business credit survey. The good news is online lending companies are increasingly stepping in to fill the credit gap for startups and small businesses, even companies with little credit history and those that may have less-than-stellar credit scores.
These alternative lenders rely on technology to speed up the application process and consider a wider range of data on a borrower, enabling them to better gauge a borrower’s creditworthiness. This approach has led to partnerships with big brick-and-mortar lenders, resulting in a broader range of financing options for young businesses.
Filling the Void
The rise in alternative lending companies came about after traditional financial institutions pulled back on lending following the 2008 financial crisis. In the years since, these lenders have quickly grown into a key provider of business loans. In 2016, 19% of businesses applied for a loan from an online lender. That number grew to 25% in 2017 and then 33% in 2018.
Most alternative lending companies offer a variety of loans for businesses, including a standard fixed-rate loan that gives borrowers up to 5 years to pay it off. Businesses can also opt for a line of credit, which gives them a specific amount they can draw upon as needed, essentially functioning like a credit card.
Alternative lenders are more likely than traditional financial institutions to lend smaller amounts. And their online application process tends to be faster and easier. Some lenders will also allow companies to finance specific big-ticket purchases, like trucks, refrigerators or computers, using the equipment as collateral on the loan.
As the lines between technology companies and banks have blurred, it’s given rise to more innovation in lending products available to small businesses. For example, startups can now use their credit cards to cover expenses typically paid by cash or check, giving the business more financial flexibility using a line of financing they already have.
Why are small businesses increasingly turning to online lenders? Because they’re more likely to be approved for a loan, even young businesses with minimal credit history. Small businesses deemed to be a medium or high credit risk were approved for funding by online lenders 76% of the time in 2018, according to the Fed.
Getting approved for a business loan from a conventional lender, especially if it’s backed by the Small Business Administration, typically requires businesses to have a good credit score, put up collateral, and present a business plan. You may also have to provide tax returns and other financial records.
Traditional lenders also generally weigh at least one or two years of a company’s cash flow history. In contrast, online lenders may only need to look over three months’ worth of bank statements and will accept average credit scores. And they’re more likely to look beyond collateral when sizing up their applicants’ creditworthiness and instead focus on a company’s monthly cash flow.
As alternative lenders take a bigger slice of the business lending market, some traditional lenders have decided to partner up with them. Essentially leaning on the online lenders’ technology to determine which borrowers are creditworthy. This means small businesses may have a better chance of getting financing from banks that partner with alternative lending companies.
A Proper Foundation
Despite the wider access to loans from alternative lenders, startups should ensure they’re taking steps from the get-go to optimize their finances in order to maximize their chance of qualifying for a loan. One of the best things you can do is manage your cash flow effectively. Not only is this an area that lenders will focus on when evaluating you for a loan, but it’s key to ensure that your business remains on a profitable path.
Using cloud-based software to track finances and automate tasks like paying bills, sending out invoices to customers, and even managing payroll, can help you get a firm grasp on your cash flow, so you can spot any potential shortfalls well in advance. It’s these types of financial pitfalls that put many startups in the position of having to get a loan to begin with.
One key improvement you can make is to coordinate your accounts payable and accounts receivable. This comes down to sending out invoices to your customers on a deliberate schedule that takes into account when you will need to meet your most pressing cash needs, like covering payroll, paying your bills or other key expenses.
Sending out invoices automatically and accepting payment the way your customers like to pay increases the likelihood that you’ll be paid sooner, which reduces the possibility that you’ll come up short on funds to cover your business expenses.
Still, there will be times when you need a little extra help. Startups have always faced their share of challenges, but these days they at least have more options than ever for securing the financial lifelines they need to make sure they can ride out those early bumps.
Guest Contributor: Eddie Davis is the SVP of Sales & Operations for FINSYNC, a consolidated cash flow management platform focused on helping businesses grow. FINSYNC’s intuitive online tools help automate payments and accounting, and provide valuable insight through cash flow analysis. The lending network gives businesses access to fast, affordable financing. FINSYNC’s virtual community of specialists provides unrivaled support with bookkeeping, accounting, human capital management, financial analysis and corporate strategy. Connect with Eddie on LinkedIn and follow @FINSYNC on Twitter.