Exploring alternative lending
Bigstone chief executive Boyd Pederson shares his insights into the alternative lending marketplace and how small business owners can successfully navigate through the different options available.
Q: What is the current landscape of alternative lending?
The landscape for alternative lending to small business is pretty bright. I think of it on three dimensions. The first is 'who is the customer?' Is it a small business or is it a consumer?
What is their business model and how do they get their funding for the loans that they present and that lays out balance sheet lending versus marketplace lending and consumer versus business.
The third dimension is what kind of collateral is available for that customer which provides a pretty significant difference in weight to the customer based upon the strength of that collateral security. That goes for everything from completely obscure loans in small dollar amounts which is known as the payday lending market to fully secured against residential real estate at low LVRs in small chunks.
Q: Why are small businesses turning to other lenders?
The main driver is that banks find it very hard to lend cost effectively to small business.
With 1.2 million small businesses in Australia, there is a large number of folks who are older and don't want to give up the real estate collateral any longer, a large number of younger folks who simply are not able to get into the real estate market any longer, and there is a very large market of customers who don't want to or are unable to provide real estate collateral. They are simply not well served by financial institutions.
Given the costs and complexity when lending to small business and the relatively small balance sheet or the amount of money that a small business can borrow, it's just simply not profitable for the complexity and as a consequence, alternative lenders have emerged into the environment and are doing their best to satisfy this unmet demand.
Q: What are some of the challenges facing the industry?
The biggest challenge for the alternative lending industry in general is the ability to be able to accurately predict the cost of the small business borrower and to attract the small business more cost effectively at a time that they have a moment of need.
It's not very easy to find borrowers that are very good borrowers at the time of need and that's expensive. The natural consequence is you have the two business models where one is more expensive than the other and as a consequence the ones who can afford to spend a large amount of money on marketing are charging the highest amount of interest rates.
Q: What should small business owners be on the lookout for when utilising alternative lending?
The most important tip for small businesses is to not get confused by all the differences in terms and conditions and definitely be able to recognise when you're going to get a loan that small business lending is not regulated the same way consumer lending is. So you have to do your homework and to avoid getting confused, the simplest solution I can offer is to think about the trade-off that you're making.
Number one, get yourself an understanding of how much the actual cost of borrowing will be over a full year and then compare that actual cost of borrowing over a full year amongst other different providers. What you'll find is that those who ask fewer questions and provide the money quickly are much more expensive than those who ask more questions and provide the money a little slower.
Q: What are some potential pitfalls in the alternative lending space?
There are two most common traps we see with small businesses lending. The first is failing to plan ahead. Small businesses who find themselves needing cash in an emergency are often required to pay very high rates because emergency funding costs a great deal of money.
The second major trap I would say is that small businesses who fail to plan ahead don't think through what the cost of funds is and only take for granted what is quoted to them as being the actual cost of funds. You have to do the math and it is not that hard, it's just a matter of figuring out the portion of the amount that you need versus what you will pay over the course of the year, should you have to borrow that money for a year's period, and compare that again with all the different kinds of alternatives that you have.
The third major issue that customers face is the difference in the way that interest rates are charged and I am sure most small business owners who might have taken a loan out before recognise that credit cards have charged when you don't pay on time and when you don't pay on time in the business lending space you get penalty rates, so figuring out what your penalty rates are and whether or not the interest is the same. Three things here, figuring out what your fees are to access the money, which is different to your interest, second is figuring out whether your interest of fees are paid all upfront as in they are unavoidable or they depend upon how much you have outstanding over time, and the third thing is in the event that you can't pay on time, if you were to suffer additional volatility in my business, what are the actual penalty costs and flexibility of the product.
What we find is that quite a few of the borrowers that come to us are looking to refinance their expensive or inflexible borrowing at lower rates when they've caught themselves paying too much to be able to support their cash flow.
Q: What are your predictions for the future of alternative lending?
The most important prediction is that it is going to grow and become much more broadly accepted. I think we are at the very beginning of a wave of change in finance for small businesses.
One of the first players in funding appeared in 2010; by 2014 about 1 per cent of small business lending was through marketplace lending. By 2016 it was nearly 14 per cent and this year will grow quite a bit more.
I would expect that we'll see very similar kinds of growth rates in Australia because the marketplace is just as concentrated and an even more challenging position because of the highly concentrated banking market but also an investing market that expects high dividends and a capital cost base that is going up.
[Being a bubble] is what they said about the internet in 2001 and if you look at the two or three most valuable companies in the world now, they are all internet companies. It is inevitable that alternative lending will grow specifically in a small business space and become far more credible and far more broadly accepted.