Flexible financing is a must for alternative lenders – TechCrunch

Rachael runs a bakery At New York. She opened a boutique in 2010 with her personal savings and contributions from family and friends, and the business grew. But Rachael now needs additional funding to open another store. So how does it fund its expansion plans?

Due to strict requirements, extensive application processes and long turnaround times, small and medium-sized enterprises (SMEs) like Rachael’s Bakery are rarely eligible for traditional bank loans. That’s when alternative lenders, who offer simple and short applications, flexible underwriting and fast turnaround times, come to the rescue.

Alternative loans are all loans made outside of a conventional financial institution. These types of lenders offer different types of loans such as lines of credit, microloans, and equipment financing, and they use technology to quickly process and underwrite applications. However, given their flexible requirements, they generally charge higher interest rates than traditional lenders.

Securitization is another cost-effective option for raising debt. Lenders can bundle the loans they have made and segregate them into tranches based on credit risk, principal amount and term.

But how do these lenders raise funds to fill the financing gap for SMEs?

Like all businesses, these businesses have two primary sources of capital: equity and debt. Alternative lenders typically raise equity from venture capital, private equity firms, or IPOs, and their loan capital typically comes from sources such as traditional asset-based bank loans, debt companies and securitizations.

According to Naren Nayak, SVP and Treasurer of Credibly, equity typically constitutes 5-25% of capital for alternative lenders, while debt can be between 75% and 95%. “A third source of capital or funding is also available to alternative lenders – whole loan sales – whereby loans (or cash advances receivable from merchants) are sold to institutions on the basis of a forward flow. It is a ‘balance sheet light’ financing solution and an efficient way to transfer credit risk for lenders,” he said.

Let’s take a closer look at each of these options.

Picture credits: FischerJordan

Equity

Venture capital or private equity is one of the primary sources of funding for alternative lenders. The alternative lending industry is they say a “gold mine” for venture capital investments. Although it is difficult for these companies to obtain credit from traditional banks due to their strict requirements at the outset, once the founders show their commitment by investing their own money, venture capitalists and equity firms -investment generally intervene.

However, venture capital and private equity firms can be expensive sources of capital – their investment dilutes ownership and control of the business. Moreover, obtaining venture capital is a long, complex and competitive process.

Alternative lenders who have achieved good growth rates and expanded their operations have another option: an IPO allows them to raise large sums of money quickly while providing a lucrative exit for early investors.

Debt capital

Once the business is in good shape, banks may be more willing to lend money through loans and revolving credit facilities. Term loans are financing provided by traditional banks, credit unions, and Small Business Administration (SBA) lenders. Although they offer low interest rates and long payment terms, they require several indicators of security, such as a substantial track record and collateral, that fledgling alternative lenders do not have.

Darcy J. Skinner