Online Lending Platforms Ramp up to Fill Small-Merchant Void Left by Banks

With financial institutions lending less to small businesses, new, technology-based companies are moving into merchant lending to fill the void.

This is a market typically served by so-called merchant cash-advance firms, companies that lend money in the form of advances against a merchant’s expected credit card volume. In many cases, these advances are sold to small merchants by independent sales organizations. But while this market, too, has attracted new players—most notably, Square Inc. with its Square Capital product—some lenders say much merchant demand for funding remains unsatisfied.

To begin with, say the new tech firms, funding decisions take too long and tie up small companies in too much red tape. “Small-business lending is broken,” said Noah Breslow, chief executive of New York City-based On Deck Capital Inc. “It’s very, very inefficient.” Breslow, along with Sam Hodges, co-founder and U.S. managing director for rival online lender Funding Circle Ltd., spoke on Monday at the Money2020 trade show in Las Vegas, Nev.

Founded in the United Kingdom in 2010, Funding Circle expanded to the United States a year later. On Deck was founded in 2006.

Before the credit crisis of 2008, small-business loans constituted some 35% of overall bank portfolios, a number that has now fallen to just 24%, Breslow said, adding that banks turn down 8,000 small-business applicants every day. This has created a funding gap his and competing firms are seeking to fill with streamlined online application and approval processes.

Using a scoring system similar to Fair, Isaac’s FICO scoring system, On Deck can approve a $35,000 loan in minutes, he said, and a $250,000 loan in hours, compared to days for bank approval. The company has also built an integration into the online version of Intuit Inc.’s QuickBooks accounting program to offer pre-approvals to merchants when they log in.

All told, On Deck has lent $1.6 billion to U.S. small businesses, Breslow said. “Once customers try an online loan rather than a [bank] branch, they never want to go back,” he told the audience of payments and financial executives at Money2020.

Nor are the firms’ ambitions small. “We think we can be the exchange for small business credit,” said Funding Circle’s Hodges. “Small businesses are looking to expand, yet what banks are willing to do in lending has flattened out.”

The loans these firms make are unsecured term loans carrying rates well in excess of 20%. The average rate on traditional merchant cash advances, by comparison, has averaged 35% for a six-month advance. With the new online lenders, however, investors are finding new uses for their capital. “We’re connecting small businesses with investors who didn’t traditionally lend to small business,” Hodges said.

For distribution, the firms work with transaction processors, business-software vendors, even banks. On Deck, for example, has agreements with processors WorldPay and Total System Services Inc. (TSYS).

They also promise more products and services. “Business is humming,” said Hodges. “We’ve got a lot more to come.”