Overcoming Fear of the Unknown: SMBs’ Misconception of Alternative Lenders

According to CB Insights, mismanaging cash flow is the second most common reason small businesses fail. The first few years of existence are a crucial time for small businesses (SMBs). Between meeting the demands of clients and ensuring that employees are compensated on time, small business owners can find themselves caught in a juggling act. And yet, even though managing cash flow is a constant challenge, many SMBs still hesitate to get the credit they need from alternative lenders.  

Traditional Lending to SMBs Lacks Efficiency

First, let’s look at the gaps in traditional lending that create a need for alternative lenders. Gathering quality data from a single source for credit scoring is easier said than done for traditional banks and small business owners. The process is made even more cumbersome by many banks still entering and aggregating data manually. 

On the SMB end, the process is further complicated by business owners’ insufficient credit history and financial reporting. They’re often uninformed about their credit risk, how to improve their credit, and how banks assess creditworthiness. To make matters even worse, traditional banks’ requirements for the lending process, documentation, and necessary data are inconsistent and complex. 

Alternative Lenders Provide New Opportunities

For these reasons, seeking credit from alternative lenders online provides SMBs with new opportunities to improve their cash flow. Alternative lenders are nonbank credit providers who operate online and use nontraditional sources of information to determine a business’ creditworthiness.

 

To learn more about how lenders are using new methods to assess risk, check out “It’s Time to Rethink Credit Scoring” by Urjanet.

 

In the last few years, many alternative lending industry leaders have recognized the opportunity to expand their services to small-business lending. According to a recent Federal Reserve study, one in five small businesses in the U.S. applied for credit from an online lender in 2015. What’s causing this slow adoption?

Is purchasing online credit products too risky? How do these products compare to borrowing from traditional lenders? 

Information is Key

To better understand small business owners’ perceptions of online alternative lenders, the Federal Reserve conducted online focus groups. The Federal Reserve study’s key findings included the following insights about alternative lending:

• Many participants didn’t recognize online alternative lenders as being a distinct category of lenders. They thought online lenders provided a place to shop for credit from both alternative and traditional sources.
• Participants thought traditional banks would be less likely to lend to them, because of their small size.
• Small business owners associate unfamiliar lenders with shady practices.  At the beginning of the study, participants were asked about their impressions of online lenders. Participants who had never previously purchased from online lenders had negative preconceived notions. They described online lending as “the Wild West,” “largely unregulated,” and “shady.” However, once they actually visited alternative lenders’ websites they became more open to the idea.
• Terminology used on alternative lenders’ websites makes it difficult for SMBs to compare credit products. While participants initially described evaluating loan products as “easy,” they were unable to correctly identify the specific features and prices of credit products from the lender’s website. Interestingly, the participants selected for the study self-identified as the financial decision makers for their business.
• Clearly stated costs and product features on alternative lenders’ websites would make it easier for small business owners to compare product offerings. Participants suggested that alternative lenders use a standard annual percentage rate (APR) and explicitly list all fees on the website. They also prefer detailed information on payment policies, such as prepayment penalties and late fees. Lastly, participants want to be reassured of data security before choosing an online lender.

 

In essence, if alternative lenders want to persuade more SMBs to consider buying credit products from their websites then information is key. Many small business owners don’t understand the differences between credit products or why alternative lending is a viable option for them. The more information alternative lenders provide on their websites, the more prepared customers will feel to make an educated decision.

Alternative lenders can also benefit from presenting this information in a manner that is easy for business owners to understand. With clearly defined industry jargon and benefits, small business owners are much more likely to give the new kid on the block a chance.

 

Have your own ideas on what makes alternative lending a better option for small businesses? We’d love to hear your thoughts on Twitter.

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