Small business lending has declined considerably since 1995. Three alternative lenders discussed how to approach lending to small businesses in a unique way on a LendIt panel moderated by Community Investment Management Managing Partner Jacob Haar. The panelists included Able Lending CEO/co-founder William Davis, StreetShares co-founder Mark Rockefeller, and Light Capital CEO BJ Lackland.
Haar kicked off the discussion with a short introduction saying that the current small business lending system isn’t working.
“Small businesses create two-thirds of the jobs in our economy,” he said, “and produce 50 percent of the nonfarm GDP.” For these reasons, the system needs a fix. To that end, he asked each of the panelists to talk about the unique approaches they take to creating loans for small businesses.
Lighter Capital lends long-term growth capital to technology startups using a proprietary royalty agreement. They loan out $250,000. In return, the borrowing company pays 1% of their revenue each month for a 3-5 year period.
“It’s a reasonable alternative to getting money from angel investors,” Lackland said. “Bank can’t get their minds around this.” The problem with technology startups is they have no assets. What they have are the brains of their founders, computer source code, and high margins. “The average borrower has an 80% gross margin. They could be losing $20,000 a month but have $200 million in revenue. By taking some of their revenue in exchange for a loan, we can help them grow.”
Lackland said his company is 96% accurate in predicting how technology companies will grow, which means they can choose the best risks for a win-win scenario.
“We compete with VCs and angel investors,” Lackland said. “Our focus is the market. We’re a loud voice in a small chamber.”
He also said VCs refer businesses to them. In fact, they’ve become a huge source of leads for Lighter Capital. Investment banks, technology banks, and other industry players also refer leads.
“It makes it easy for us to make a connection in the industry,” Lackland said. “We raise a lot of equity money. Once companies find us, it spreads virally.”
“So you have to acquire a customer at a point where they don’t want to go to a VC and a bank won’t service them,” said Haar.
“If the customer is trying to get a bank loan or looking at an equity investor, we’ll get that business $250,000,” Lackland said. “There’s not much in the middle for these companies.”
StreetShares has identified a very large affinity group that is “sticky” allowing them to focus on core niche lending products and cross-sell other financial products.
“Our approach is to capture and monetize social loyalty,” Rockefeller said.
An Iraq War vet, his company lends money to veteran-owned businesses. The problem with veterans, he said, is they don’t get many chances to build credit because they move around a lot, so his company can view financial decisions through the lens of military thinking and help veteran-owned businesses.
“The beacons are alread out there,” Rockefeller said. “There’s a large military credit union, and that model works. We’re Uberizing.”
StreetShares builds partnerships and do a lot of targeted direct marketing. One of their niches is to finance government contracts by underwriting on a cash flow basis. A company could be sitting on five or 10 military government contracts but can’t qualify for a $30,000 loan. Because vets get priority for those contracts, StreetShares can meet their need for a loan.
“We love military vets because they’re highly targetable,” Rockefeller said. “They belong to the same organizations, and that’s a layer—fellow vets—that is a part of our social capital.”
Able Lending took a diversified P2P model and inverted it.
“We ask friends and family to take some of the risk for us,” Davis said. “We reduce the senior cost of capital to a very specific targeted form of backing. Our target is already investing in businesses, but they do it in a way that’s not equity and not diversified across many loans.”
Businesses that borrow from Able Lending get a 18%-20% market rate. By raising 10% of the loan amount from friends and family, they can reduce that to 13% or 14%.
“That’s adds a behavioral component,” Davis said. “The senior lender can charge lower before we calculate known or unknown behavioral issues on the loan.
Able Lending operates in 43 states. Surprisingly, though friends and family use the platform to invest in businesses, they make up only 20% of funding for the borrowing businesses. The other 80% are investors in the community, which means that friends and family joining the platform are investing in other businesses.
“That means during your screen process you have to select businesses that can go out and raise money from the network,” Haar said.
“Yes,” Davis agreed. “What makes a great entrepreneur? Someone who can sell. If someone is willing to take a 30% loss of capital, that is a snapshot of the type of company you want in your portfolio.”
The same skills that allow lenders to predict defaults also allow them to predict the likelihood that a borrower will respond to email, direct mail, or another marketing tactic. Davis said his company has developed those skills in reaching their target market, and that has made a big difference in their business model.