By Ianthe Jeanne Dugan & Ruth Simon – January 7, 2014
When Khien Nguyen needed $180,000 to open his 13th nail salon near Philadelphia in November, he didn’t go to a bank. Mr. Nguyen’s credit score had dropped during the recession, so he figured a bank would put him through weeks of aggravation, then reject him.
He turned instead to one of the nonbank, short-term lenders that have been gaining traction since the financial crisis. The lenders cater to small businesses, often at high cost.
Delaware-based Swift Capital reviewed his financial records and social-media sites such as Yelp and Facebook for reviews, then dispatched someone to one of his salons to pose as a customer. Swift wired him the money a few days later.
Mr. Nguyen is paying 14.9% interest over the loan’s six-month term—the equivalent of about 30% annually.
Payments are drawn automatically each day from his business bank account. “It’s not cheap, but they served my needs quickly,” he says. About two dozen such nonbank lenders—including OnDeck Capital Inc., Kabbage Inc. and CAN Capital Inc.—lent about $3 billion collectively last year, double the 2012 total, estimates Marc Glazer, chief executive of Business Financial Services Inc., a lender with about $100 million of such loans outstanding.
These short-term lenders want to become the go-to financiers for business owners needing quick cash, often $50,000 or less. “It is a substantially underserved segment of the economy,” says former American Express chairman and chief executive James Robinson III, an investor in OnDeck alongside Google Ventures, SAP Ventures and PayPal co-founder Peter Thiel.
Banks generally require solid credit scores and spend weeks reviewing financial statements, tax returns and business plans. Biz2Credit, an online loan broker for small businesses, says an analysis of loan applications made in December through its website showed big banks approved 18% of loan applications by its customers in December, while small banks approved 49%.
Various nontraditional lenders have stepped into the void. Peer-topeer online-lending platforms channel funds from ordinary investors to borrowers. Private investment partnerships, including hedge funds, make direct loans to struggling businesses, often with costly strings attached.
Short-term lenders such as Swift and OnDeck typically structure their loans to be repaid in months, not years. To reduce risk, payments are collected daily or weekly, enabling lenders see how loans perform “in real time, as opposed to the wait-and-hope model,” says Daniel DeMeo, chief executive of New York-based CAN Capital.
Interest rates on such loans can run in excess of 50%, on an annualized basis, much higher than on conventional bank loans. Usury laws limiting interest rates generally don’t apply to the short-term lenders. Some of the loans are originated in states that don’t cap interest rates on commercial loans. Others are structured as private contracts between two businesses. Many loans come through brokers working on commission.
Speaking at a recent Small Business Administration conference, Treasury Secretary Jack Lew said the government wants to “do more to knock down barriers to financing,” and he voiced support for new approaches to lending. “These companies are using alternative measures to assess a business’s ability to pay back a loan,” he said. “They use data like real-time shipping schedules, records held in a business’s accounting software, and even social-media traffic to determine creditworthiness.” The government, he said, wants to provide access, with a borrower’s permission, to certain information reported to the government.
Since launching in 2007, New York-based OnDeck has issued more than 20,000 loans totaling more than $825 million. Fifty-six of its 225 employees have backgrounds in math, statistics, computer science or engineering and work on data analysis, credit modeling and technology infrastructure. The typical customer is a restaurant, auto-body shop, beauty salon, retailer or physician seeking about $35,000—businesses that often have trouble getting traditional bank loans, says OnDeck chief executive Noah Breslow.
Ron Wendolowski, co-owner of DJ’s Delights LLC in Asbury Park, N.J., sought cash to expand in 2012. He says he was turned down by a bank because the business was only two years old. So he applied to OnDeck.
OnDeck analyzed credit-bureau data and DJ’s cash flow, and electronically checked state corporate filings and court records. It even checked diner reviews on social-media sites Yelp, Urbanspoon and Foursquare. Within a day, it approved a $6,000 loan with a six-month term. Since then, DJ’s has taken out three more loans from OnDeck. The most recent, for $20,000, carries a ninemonth term. The daily payment requirement equates to a 34% annual interest rate. “The rates are higher than bank loans, but it’s a lot less aggravation,” says Mr. Wendolowski.
Mr. Breslow says OnDeck customers are willing to pay a premium for “our speed, convenience, certainty and electronic delivery,” and many “have not been served by banks.” Alternative lending to small businesses expanded during the financial crisis as bank credit dried up. The value of outstanding commercial loans under $1 million at federally insured banks—a proxy for small business—has declined by 15% since 2007, on a non-inflation-adjusted basis, to $284.5 billion in last year’s third quarter, according to the Federal Deposit Insurance Corp.
In 2008, when the financial crisis hit, sales at Robin’s Nest Floral and Garden Center in Easton, Md., dropped by 15%, according to owner Ken Morgan. The 30-year-old company needed $50,000 for a shipment of Christmas decorations. “I went to the bank, where I’d always done business on a handshake, and they were scared and having their belts tightened,” he says. He was turned down.
Mr. Morgan applied to Business Financial Services, which examined his company’s credit score, sales volume, cash flow and other financials—then clicked on Facebook.
The Robin’s Nest page was “continuously updated with promotions and events,” an underwriter reported. “There are numerous ‘likes.’ ” The business topped Google searches of area florists, and had a stellar Better Business Bureau rating.
Business Financial Services wired the money, which was repaid within six months. Interest payments totaled about 18%—an annual rate of more than 35%. “This isn’t cheap money,” says Mr. Glazer, CEO of Business Financial. “But we charge these rates because we are taking a risk, and losing millions every year.” As private companies, the lenders aren’t required to disclose default rates. Several said they run in the single digits.
OnDeck says it approves 25% of all applicants and 75% of those meeting its initial business and credit filters, which include being in business for at least one year and having at least $100,000 in annual revenue. Swift says it approves more than three-quarters of applicants. “If we looked at just the credit score, the way a bank does, that eliminates more than half the market,” says chief executive Ed Harycki. Swift says it has provided $350 million to more than 10,000 businesses.
Unlike banks, the short-term lenders don’t take deposits, so they need other sources of capital to fund the loans. OnDeck has an $80 million credit facility from a syndicate that includes Goldman Sachs Group Inc. “They have a successful business model that we like,” says a Goldman spokesman.
This fall, OnDeck secured another $130 million from, among others, KeyCorp. Adam Warner, president of Key Equipment Finance, says loans to OnDeck and to CAN Capital are “a way to diversify our small business lending.
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