Alternatives: Crowdfunding fills small-business loan void
Small banks reduce lending by $100 billion; Crowdfunders join banks to source loans
Latest statistics from the Federal Reserve Bank of San Francisco show that the US’s small banks – with assets of less than $1 billion – are continuing to lend less to small businesses.
About 40% of small businesses use bank credit excluding credit card loans, yet smaller banks, particularly those in a weakened financial position, have been withdrawing from lending in commercial real estate, and commercial and industrial loans of under $1 million, says the report from the San Francisco Fed.
According to the Small Business Administration, banks held $607 billion in outstanding business loans of $1 million or less last year – $100 billion less than in 2008.
The decline in small business lending has led to the growth in the number of crowdfunders, which gather investors online to lend to individuals or small businesses, and have been gaining momentum since the credit crisis.
|Candace Klein founded SoMoLend, a crowdfunding platform for small businesses|
There are some 20 crowdfunding platforms globally that specialize in loans. It is estimated that by the end of this year they will have lent almost $1.1 billion. Candace Klein founded SoMoLend, a crowdfunding platform for small businesses, in 2011. Klein, a corporate lawyer and former mezzanine debt analyst, worked with banks and start-up companies, many owned by women. She began to research crowdfunders and micro-lenders after witnessing her legal clients being adversely affected by the credit crisis in 2008 and 2009.
In 2010, she launched Bad Girl Ventures, which provides loans of up to $25,000 to women, with the requirement that the business owners have to take nine weeks of training in finance and business with Klein’s firm first. "In the first year, we had over 1,000 women apply," she says. "We have considered 560 of those applications and, along with partners, we have funded 38 companies with $2.2 million. But the question then and now is – what can we do for the rest?"
An online crowdfunder seemed the obvious solution, she says. "I saw the business owners were building networks and relationships, and that loans were being made informally, but I thought maybe a web-based platform for lending could be a strong addition."
This new area of lending being opened up by non-banks has been deemed a threat to banks – particularly to their credit card franchises. The crowdfunders are taking away small amounts of business from banks, but they are growing so rapidly that if banks do not take notice they might lose out.
Klein, however, says banks can and should see crowdfunders as an opportunity for partnership. The structure of SoMoLend differs from some crowdfunders in the US because of the larger size of loans. Many crowdfunders in the US, to comply with banking regulations, will write loans and sell the notes to a bank in return for a fee, and therefore act as intermediaries. SoMoLend, however, acts more like a provider of customers to banks and other financial institutions. The platform was piloted with KeyBank and in May opened up to other banks, foundations, cities and family offices.
"Banks want to make small loans but it takes them 17 hours to make a $10,000 loan or a $1 million loan, so it is not economical for them to do so," says Klein. "What we do is take about 13 hours out of that for them by analysing the borrower and underwriting it."
SoMoLend has a patent-pending credit underwriting algorithm that bases a borrower’s creditworthiness not only on financial history and behaviour but also, among other criteria, on their social reputation online and ability to pay utility bills. Each borrowing company is given a rating from one to five that will determine the length of the loan and interest rate. The banks and other investors into SoMoLend then have the opportunity to decide on the geographic location, demographic and risk rating of the loans they wish to invest in. "We essentially provide a pipeline of deals to the banks that they can choose from," says Klein. And as each loan matures without default, the borrower can then borrow at a lower rate.
SoMoLend has had more than 500 borrowers sign up since opening up its platform in May and 40 lenders have joined KeyBank as loan providers. "We’re actively closing loans every month, and expect to see the pace of loans closed increase exponentially with the solidification of the Jobs Act in 2013," says Klein. The model of teaming up with a crowdfunder looks ideal for community banks and credit unions that want to make loans to receive interest but do not have the resources to originate new customers.
"We have the technology back-end that the community banks and credit unions cannot afford," says Klein.
She expects larger banks to also start to make a play in crowdfunding. "Hedge funds are extremely interested and the larger banks will follow," she says. "Given the complexity of the technology and regulation involved, I would foresee banks instead looking to acquire a crowdfunder as the industry grows."