How to Choose the Right Lender for Your Small Business
August 4, 2022
The first step to financing your startup or small business is choosing a lender. This way, you get the funding you need to drive growth and build an organization that can last the test of time.
The structure of modern financing offers you a host of potential funding options. However, the changing economic situation also adds uncertainty to the process, infusing your search with more complexity.
Here, we'll give you the information you need to get started on the process. We will look at the different lender options business owners have. At the same time, we'll outline the things to consider when selecting a lender, so you can focus on the segments of the market that will grant you the best possible partner in building your startup.
Finding the right lender in a fast-changing economy
The last several years have seen a rapid revolution in the financial space. The projected revenues for the fintech industry for 2022 will reach nearly double the total seen in 2017. Thanks to this growth, the market size will reach nearly a third of a trillion dollars.
As part of this, financing has poured into the sector. TechCrunch estimates that fintech drew $131.5 billion in venture capital funding in 2021 — nearly a fifth of the total amount of this kind of investment given out during the year.
But even as interest in these alternative financial models spiked, the economic conditions in which they operate began to change quickly. Since 2021, interest rates have begun to increase substantially. Financial markets, including valuations for some of fintech's most high-profile players — companies like Paypal, Affirm, and SoFi — have plunged.
Many of these famed names in the space focus on personal finance. However, they only represent the tip of the fintech iceberg. The rapid growth of the sector has fueled the creation of many business-focused lenders that can serve as excellent partners for your startup.
The rapid growth of the [financial] sector has fueled the creation of many business-focused lenders that can serve as excellent partners for your startup.
Still, the unpredictable nature of the current economy puts an emphasis on choosing the right financing source. Should you focus on the emerging fintech space, despite the near-term headwinds? Or are you safer going with tried-and-true banks? Or should you explore a peer-to-peer option offering, letting you find a solution more specifically designed for your business?
What are the different types of business lenders?
To help you get started in choosing the right lender, it's important to understand the broad options at your disposal. Here are some of the benefits and drawbacks of the major types of financial partners available:
These are the traditional lending institutions that have long dominated the lending space. Many of these exist as multinational mega-corporations — think of the Bank of Americas or Citis of the world.
Well-Established Institutions: Banks are safe, stable institutions. They have deep pockets and are supported by a vigorous regulatory apparatus.
They Offer Additional Services: Because of their broad offerings, you might have access to other financial services. From bank accounts to financial management to other sources of funds (like lines of credit), your loan might become part of a deep relationship with a trusted institution.
High Requirements for Loans: To maintain the safety and stability that serve as the foundation of their reputations, big banking institutions must remain risk averse. As a result, they typically present a high bar for qualifying for a loan.
Collateral Might Be Necessary: As an extra protection for the bank, the lender might ask you to put up some of your business assets as collateral. For some startups, you might be asked to personally guarantee the loan.
Loan Process Can Be Complicated: Big banks are often layered with slow, cumbersome bureaucracies. That means it might take a long time to gain approval, with plenty of paperwork along the way.
The term "fintech" exists as a combination of "finance" and "technology." The industry was built on the idea of applying a Silicon Valley approach to traditional banking practices. This segment makes its reputation on artificial intelligence, data analysis, and algorithms.
Innovative Solutions: Fintechs pride themselves on an innovative approach to finance. As such, you might have access to products and structures not available through other types of lenders.
Streamlined Process: A machine-driven approach strips down the lending process. Much of the communication with fintechs is automated, which means getting an answer (and potentially the money) much faster.
Lack of Personal Touch: A heavy focus on AI and data analytics means much of the human conversation is stripped out of the process. You won't get much of a chance to sell a potential lender on an innovative vision.
Untested Processes: Because they are new, the innovations pioneered by fintechs don't have a long track record. The industry grew tremendously during a period of historically low interest rates. However, as economic conditions change, it remains unclear how this part of the market will respond.
Ever borrow $50 from a friend after realizing you showed up at a restaurant without your wallet? That's the heart of peer-to-peer lending. However, on the business scale, the process takes advantage of fintech techniques to connect individual lenders with companies looking for cash.
Typically, peer-to-peer lending is facilitated by third-party platforms. These are fundamentally fintech companies, but they don't provide the funds themselves. Think of it like an eBay or Airbnb of finance, matching potential lenders with startups looking for cash.
Lower Rates Possible: Because they operate as lending markets, you can often find lower rates on peer-to-peer platforms.
Different Types of Lenders Available: Peer-to-peer platforms offer access to a broader array of potential lenders. As such, you can find sources of funding that are ideally suited to your startup.
Fewer Protections: Turning to peer-to-peer options means stepping outside the strict regulatory environment surrounding banks. This flexibility provides some of the benefits listed above, but you need to be aware of the looser set of protections involved.
How to select a lender for your startup or small business
Now that you've gotten a glimpse of the general market, it's time to begin the process of finding a specific lender. No matter what type of institution you want to pursue (bank, fintech, or peer-to-peer), there are some steps to consider to find a deal that best suits your startup:
Assess Your Funding Needs
Before launching a search for a lender, understand exactly what you are looking for. This starts with the amount of money you need. At the same time, consider the terms that you would want, ranging from your dream deal to the minimum conditions you'd be willing to accept.
Before launching a search for a lender, understand exactly what you are looking for.... [C]onsider the terms that you would want, ranging from your dream deal to the minimum conditions you'd be willing to accept.
Prepare the Necessary Paperwork
Get your house in order before communicating with any potential lenders. Prepare paperwork like P/L statements, balance sheets, tax returns, and future projections. This will help you determine your funding needs. At the same time, you'll have the documentation handy when you begin discussions with possible financing partners.
Research Your Options
This article gives you a start in planning your lender search. However, even within each type of provider, you can find significant diversity. Seek out specific options and decide on the best alternatives to pursue in more detail.
Negotiate When Possible
Even after you've zeroed in on a potential financing partner, don't necessarily accept the first offer. A little conversation could help you sweeten the terms. It's not always possible, especially given the reliance on algorithms in modern finance. But you might be able to improve the lending terms through negotiation.
Finding the perfect lender for your small business
The recent rise of fintechs and other alternative lending companies has changed the financial landscape. Startup founders and small business owners have more options than ever when it comes to selecting a lender. However, more choices and a changing economy add complexity to the process.
As such, it takes increased research and a deep understanding of the market to select the optimal lending option. Use the information here to determine which type of lender is right for your company and to create a framework for finding the ideal partner for your financing needs.