From SCORE Richmond by Doug Carleton:
Banks have never been particularly fond of lending to small and startup businesses. Probably the primary reason is that many early-stage businesses have not built up the strength and cash flow to make them less risky borrowers, and a lot of startups fail in the first year. The perceived wisdom has generally been that about half of startups do fail in the first year. But according to numbers from the SBA Office of Advocacy’s 2018 Frequently Asked Questions, roughly 80% of small businesses survive the first year, and a new report form the Kauffman Foundation – “2017 National Report on Early-Stage Entrepreneurship” comes to the same general conclusion – that approximately 80% of small businesses do survive their first year. And getting back to banks, one of the other reasons that they shy away from high-risk small business lending is that they are heavily regulated. During, and as a result of, the 2008 recession regulators came down hard on many banks for making risky loans, and that fear of being beaten up by regulators has not yet completely gone away for banks.
So even though online lenders were around at the time of the recession they were not a significant force in the lending marketplace. But now with the dramatic rise in computing power over the last five years, massive amounts of data on consumers has become available and it has allowed online lenders to create algorithms that can analyze data in seconds to create a risk profile of a potential borrower. And a great amount of that data comes from mining consumer behavior online. We have been witnessing the birth of BIG DATA. There is enough information about you out there everywhere to create a pretty accurate profile that an algorithm can analyze for many purposes, not just lending.
Since most small business owners don’t think about or plan to borrow money in the near future, depending on how urgent the need is, an application to a bank is likely to take somewhere in the neighborhood of 30 days, give or take, to make a decision, although this is beginning to change as some bankers wake up to the fact that the same data that the online lenders use can be used by a bank. Fancy that. So if a small business owner suddenly needs a working capital loan or a loan to buy a piece of equipment that could substantially improve their profitability, the online lenders are there, and they make decisions fast, and if the result is approval you can often have your money in a few days or less. As is always the case, there is a cost to be paid. Online lenders are more expensive than banks – often much more. But if you need money fast or something bad could happen, you pay it because the consequences of not getting the money could be serious.