Applying for a small business loan online is more like dating than you might realize. When the alternative marketplace lending industry began, very few underwriting standards were universally adopted. Every lender had their own secret sauce and they sold their expertise to venture funds and hedge funds with claims that automated lending decisions were the wave of the future.
In some cases, they were right. But for the most part, the industry has actually taken a step back and implemented more traditional methods that the commercial banking industry has been using for decades, if not centuries. One purely digital trend that did emerge, and one that appears to be growing, is the use of digital data points such as social media and ratings.
A Brief History
In the years that immediately preceded the financial crisis, commercial and community banks began to rely heavily on FICO scores. (FICO is a bureau that combines credit agency scores to create one holistic personal credit score.) These scores were heavily weighted in the decision-making process, ultimately helping to contribute to the credit collapse. Because the nation was in a relatively positive (albeit unrealistic) credit environment, people’s scores were likely higher than they should have been, and the banks had extremely low thresholds then compared to today.
This situation led to trouble, as Karen Mills and Brayden McCarthy recently observed in their Harvard Business School report on marketplace lending. “After poor experiences with underwriting by FICO scores in the years leading up to the Great Recession,” they write, “banks have largely abandoned automated underwriting and reverted to manual underwriting. Banks often underwrite based on evaluating bank statements, tax returns, balance sheets, income statements and credit reports with a pen, pencil, calculator, and spreadsheet.”
The regulations ushered in after the financial crisis—most importantly those in the Dodd-Frank bill—created such a host of new requirements for traditional banks that they brought small business lending to a virtual halt. Even as the economy began to improve, small businesses wound up locked out of the recovery due to a lack of available loans from traditional banks. The main reason is that small business lending is time consuming and far more complicated than personal, student and auto lending—even mortgage lending—the bread and butter of traditional banks.
The Rise of Digital Underwriting and Marketplace Lending
A few intrepid companies saw great opportunity in the regulatory crunch that banks faced in the fallout of the financial crisis. Companies such as Lending Club and Prosper created digital gateways that matched consumers with investors willing to offer loans through an online marketplace. After some initially rocky steps, they quickly found a niche and grew rapidly in the years that followed. On the small business front, companies like OnDeck Capital took advantage of the reality that banks were unlikely to re-enter the small business lending arena any time soon. In both personal and business lending, these upstarts have certainly had their ups and downs, but there’s no question they have changed the game forever.
Marketplace lenders might have more time than they previously thought to get their proverbial ducks in a row.
As we’ve said before, marketplace lending will in all likelihood be regulated someday. But it’s also likely that this effort will slow down considerably given the Trump administration’s position on deregulation. Marketplace lenders might have more time than they previously thought to get their proverbial ducks in a row.
Regulatory oversight or not, the marketplace lending industry has undergone self-initiated changes that more closely resemble standards and practices adopted from traditional lenders. Increasingly, online lenders will look at the physical documentation below, so it’s important that you have these resources available before you apply for an online loan:
- balance sheets
- profit and loss statements
- statements of cash flow
- business banking statements
- merchant processing statements
- certificate of incorporation
- commercial mortgage statement or lease
Some lenders can examine your online bank accounts (with your permission) as well as your financial reporting system (such as Quickbooks.) These innovations have given online lenders an edge in terms of speed. This ability to quickly create a profile based upon a borrower’s credit profile and real-time information is a tremendous advantage that traditional banks have been slow to adopt.
“Online marketplace lenders use electronic data sources and technology-enabled underwriting models,” note Mills and McCarthy, “to automate processes such as determining a borrower’s identity or credit risk. The data sources used to determine a borrower’s credit risk, for example, usually include traditional underwriting statistics, but they also often include real-time business accounting, payment and sales history, online small business customer reviews, and other non-traditional information.”
Yes. Online small-business customer reviews. But that’s not all. Some lenders have gone so far as to claim that social media activity of both the business and the business owner now factor into the underwriting equation.
Remember when you told teenagers in your family to be careful about what they put on social media because colleges or potential employers might hold them accountable for what’s on their profiles? Time for a taste of your own medicine.
The bottom line is that it’s a digital world, and you must assume that everything is visible to the outside world.
It turns out that your Yelp reviews or Google ratings might matter more than you think. Don’t have a website? Might be a strike against you. Not active on LinkedIn? That might say something negative about your ability to drive new leads and grow your sales.
The bottom line is that it’s a digital world, and you must assume that everything is visible to the outside world— particularly if someone out there is thinking about lending your business money.
Fear not! We’ve assembled some very useful guides to help business owners take control of their digital profiles. Our free business resources page is chock full of useful downloads to help small business owners manage their digital lives and present themselves in a good light. Even if you’re not applying for a loan, you’ll find value in these guides.
So, before you get hitched to a lender, make sure you put together your most flattering online profile. We might have learned not to judge a book by its cover, but it sure doesn’t hurt to have a good-looking one.