The Role of Alternative Lenders

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1 The Role of Alternative Lenders AND THE RELEVANCE TO SMALL BUSINESSES TODAY Business Lending. Simplified. Christophe Choquart VP Business Development & Strategic Partnerships Office : Fax : cchoquart@ioufinancial.com ioufinancial.com

2 THE ROLE OF ALTERNATIVE LENDERS WHAT IS HAPPENING IN THE INDUSTRY Small Businesses Accessing Capital Access to capital is a critical concern for small businesses*, as a large portion are challenged to find adequate financing to sustain or grow their businesses. Prior to the credit crisis of 2008, many small business owners leveraged home equity loans, large credit card limits and personal lines of credit to sustain and grow their businesses. The financial meltdown, shrunk or eliminated many of the capital sources small businesses had, and the credit window at banks was closed to most businesses. To this day, banks have never found micro-loans (<$150,000) profitable. This dynamic was the genesis for market entrants to provide small businesses access to capital. Small Business loans originating with either direct or peer-to-peer lenders are generally a much higher cost than their previous counterparts (lines of credit or home equity lines). However, this new access to capital is much easier for small business owners to obtain, with less paperwork and faster funding (hours and days vs. weeks or months). Over the past few years, online lenders have made their mark in the industry by: Focusing on Innovative Technology Speeding up the Underwriting Process Lessening Documentation Requirements *For the purposes of this paper, we are defining small businesses as typically having less than 20 employees and an annual revenue less than $10 Million. 2

3 Alternative Lenders 1 Because of the gap left by the banks and the ease by which merchants can receive capital, the alternative lending industry will continue to grow quickly, with a projected market of $206 billion by 2025, according to Growth Praxis. Alternative lenders offer three advantages over bank loans. First, the process to apply is simple and requires little to no paper work. Second, they provide loans quickly, usually within one to three days, versus the weeks and months it takes to secure a bank loan. Third, banks seldom make business loans for less than $1 million because they aren t profitable enough for these large institutions. makes loans from $5,000 to $150,000 in as little as 24 hours. As mentioned, the alternative/on-line lending market is composed primarily of two lender types: DIRECT LENDERS These companies originate loans funded with their own capital. Cost of capital for these lenders runs from a lowest reported of 8% to the mid teens. Direct lenders may sell some or all of the loan portfolio to third-party investors, while others portfolio and balance sheet their loans. IOU Financial does a blend, keeping 80% of loan production on its balance sheet, selling the other 20% to hedge funds. PEER-TO-PEER (P2P) LENDERS These marketplace lenders match loan requests with investor s return/risk tolerances. P2P platforms may partially fund these loans, or may act only as intermediaries to bring borrowers and investors together. P2P lending traditionally has been associated with personal loans, but recently some have been offering small business loans. In either guise, alternative lenders provide speedy access to capital to small businesses across the spectrum of credit profiles, access that is typically not available from banks. Alternative lenders provide businesses to quickly access the capital they need to grow. 3

4 THE ROLE OF ALTERNATIVE LENDERS A LOOK AT PRICING The Cost of Alternative Lenders Traditional bank practices lend to only the most credit-worthy businesses, with collateral almost always being tied to a loan. The application and underwriting process at a bank is structured to mitigate nearly all loss risk and in-turn takes weeks and months to finalize. This freezes many good, viable companies out of the running for bank loans, and delays opportunity for those who are bankable. As a result of bank s inherent low cost of capital and conservative underwriting, borrowing costs are low. UNDERWRITING Alternative lenders, allow business owners to apply using on-line platforms with datadriven insights and advanced algorithms based on hundreds of data points including cash flow, personal and business credit, and even social media and consumer reviews. Because of this technology, alternative lenders can pre-qualify loans in seconds and approve them as quickly as a few hours. COST OF CAPITAL Traditional banks are able to get their capital for a very low cost, currently targeted by the federal reserve at 0.40 percent. Compare that to the cost of capital for alternative lenders, whose cost of capital ranges between 8 percent and 15 percent, and can have heavy restrictions and covenants by the issuing fund or credit facility. DEFAULTS There is little argument that the underwriting and vetting process traditional banks take is far more robust and mitigates risk to a greater degree, but the process is slow compared to the speed at which alternative funds can be available. This speed can increase the risk of default because, loans are not collateralized, and separate unscrupulous lenders may stack multiple loans on one small business. Those lenders that take 3 rd and 4 th position typically care about their profits, not the health of the businesses accepting funding. RESULTING COST In order for alternative lenders to ensure they generate an appropriate yield, they must factor in: their cost of capital, risk score of the merchant, loan term and cost to serve (operations, commissions, etc). These variables drive pricing of the loan. Unlike collateralized loans, the lender can not build in the asset value of the collateral to reduce pricing. Alternative lending is done on a promissory note basis, lending without collateral increasing the cost to cover defaults across the portfolio. 4

5 QUALIFYING FOR FUNDING A merchant can qualify instantly on-line by meeting some typical requirements. As mentioned, small businesses turn to alternative lenders when they lack the credit ratings or business history necessary to obtain a bank loan. It is therefore critical for potential borrowers to understand how to qualify for a commercial loan funded in as little as 24 hours. For example, sets these very reasonable requirements: LOCAL SHOP OWN OR CO- BEEN IN MAKE DAILY ANNUAL OWN BUSINESS DEPOSITS REVENUE at least at least at least at least 80% 1 year 10/mo $120K Borrowers and co- The merchant s busi- A retail business The business must have borrowers must own at ness must have been must make at least 10 an annual revenue of least 80 percent of their in existence for at least deposits a month into a at least $120,000. IOU business. one year. On average, business bank account. clients generate on av- IOU clients have been in erage $1.3 million in an- business 11 years. nual revenue. 5

6 THE ROLE OF ALTERNATIVE LENDERS CONSIDER THE CALCULATIONS High APRs Are Not All They Seem APRs incorporate both interest rates and one-time fees so interest rates are lower than the APR, but APR is not the measured by which an alternative small business loan should be measured. APRs are often misleadingly high. For example, if you take $100 out of a checking account at a non-bank ATM that charges a $3 fee, you re paying the equivalent of a 1095% APR. Owners must consider commercial loan APRs in the context of their business opportunity costs and profit margins. Even if a non-collateralized loan has a stated APR of 60 percent, businesses may be able to quickly recover their costs if they invest the money in high-roi activities that grow the business and/or eliminate other structural costs. The key is for small business owners to understand that APR is their total cost of capital, which they should optimize for their targeted return on investment. Good lenders make this assessment as part of the loan advisory process. is one example of the responsible lenders who understand this dynamic. Businesses that borrow money for lower- ROI needs (i.e. hiring, general working capital, etc.) must be very diligent in how they borrow. The following chart shows how customers at put their loans to work. As you can see, the bulk of loan money goes to high-roi/growth activities (equipment purchase and business expansion). The cost of lost opportunity is also something businesses need to look at when evaluating their financing options. Waiting weeks or months for lower cost funds can make sense, but it can also mean businesses just delay their growth curve or miss opportunities which could far outweigh the difference in total costs. 6

7 YOUR CUSTOMERS CAN BENEFIT Do your customers have trouble accessing capital to grow? Do you work with seasonal businesses that cannot complete projects in their off season? CONSIDERATIONS Businesses need to understand the way alternative lenders determine loan amounts. For example, takes into consideration a combination of credit history and cash flows to ensure the business does not overextend its debt. These key limits of total debt a business should take on without putting the enterprise at risk have been determined and refined for years. considers stacking as an event of default, and warns merchants about the dangers of too much debt. Another important consideration applies to repayment cash flows. Some lenders enforce a monthly payment date, other cash advance companies take a percentage of daily credit card receipts. For merchants with uneven cash flows, the monthly repayment amount can look like a mountain of cash. s policy of collecting small automatic payments directly from customer checking accounts converts that monthly mountain into small molehills, a much less painful way to pay back a loan. No matter the considerations, loans from alternative lenders should always be reviewed carefully so that a merchant understands the costs and terms completely. CONCLUSION Commercial loans from alternative lenders fill a critical need for businesses in the lending industry. Banks, CPAs, Insurers and other financial advisers need to understand how the alternative lending market provides a credible opportunity for their small business clients to grow. 7

8 THE ROLE OF ALTERNATIVE LENDERS WHY IOU FINANCIAL IS THE First Choice in the Industry Why is regularly chosen by merchants, investors, partners, and resellers? Because our product, service and support is superior! See how everyone benefits working with us. BORROWERS Loan Officers understand small business, and have knowledge of specific verticals, such as, restaurants, medical practices, specially retail, etc. They are trained to advise merchants on the best financing solutions for their respective business and needs. Transparency is an important aspect of our lending, and IOU always explains the product and process to each merchant thoroughly. PARTNERS Working with allows partners to help keep their clients balance sheets safe, while encouraging them to continue using their product/service. A customized approach, allows partners to stay as hands, on or off as needed during the lending process. Timely payments for referral business allow your business to profit through supporting your clients business growth. RESULTS By providing exceptional service to partners, while helping small business owners access the timely and responsible capital they need - is able to grow communities across the US and Canada. See what our platform has to offer merchants! Loans from $5,000 to $150,000 - and renewals available when the loan is 40% paid down. An easy online application that offers pre-approval in just 3 minutes. Risk Free - the merchant s credit score is not affected during the application. No pre-payment penalty upon completion. Proprietary cash flow analysis model estimates the maximum debt repayment capacity, so owners are never overextended. Montreal, QC HEADQUARTERS Atlanta, GA OPERATIONS 8

9 Our staff is ready to welcome you and your clients into the IOU Family. We treat every customer like a business in our very own community, by offering assistance towards individual s success in a responsible manner. has dedicated staff members in sales, processing, underwriting, client services, and finance motivated to offer the best customer service daily. Our team understands how critical the success of a small business is to the community it serves. When we can help one small business succeed, the ripple effect of economic impact is immeasurable. We are looking to continue creating this positive affect across the US and Canada. With your help, we believe we can reach more businesses than ever before. See some of our staff members below that are dedicated to your success! 9

10 Let s work together! is dedicated to fuelling the growth of small businesses so those businesses can stimulate economic growth in their community. Bring this positive impact to your small business network by partnering with. We are here to support you and your clients throughout the lending process. CHRISTOPHE CHOQUART VP of Business Development & Strategic Partnerships P: F: cchoquart@ioufinancial.com