Early startup funding strategies are critical to whether they stand a chance in the market. It can be make or break time, and for some, there are limited options without giving away equity. On the face of it, digital loans may sound like traditional bank loans, except with an online interface – but in reality, it is much more radical.
Digital Lending Boom – How Startups Are Benefiting
Digital lending has experienced a lot of growth in the past five years. 2021 saw almost double the number of startup funding strategies for digital lending compared to 2020. Of course, the economic catastrophe of the pandemic was a catalyst, but like many shifts during that time, it was a necessary and permanent one.
Alternative solutions were becoming particularly popular among Gen Z consumers, who inherently lacked a rich credit history to secure loans the traditional way. Financial apps were the new way of doing things, with high street banks rapidly losing market share to online challenger banks, as well as the rise of Robinhood for digital investments.
The beneficiaries of this new online focus were, of course, new and small businesses. After all, 40% of the aforementioned startup funding strategies went into SMB lenders, as these become the sole target for fast online loans with generous approval rates.
How Loan Comparison Sites Help Entrepreneurs Find the Best Rates
As long ago as 2014, a report was published on how financial comparison sites significantly increase consumer confidence and understanding. This is a very difficult thing to be educated on by a third party without the use of the internet, and customers previously needed to rely on the expertise of bank workers, who were far from unbiased.
The landscape is no different ten years later, except that there are far more digital-first lenders. This heightened competition generally leads to cheaper products, and the nature of comparing loans means getting businesses the lowest possible rate (or finding a willing lender for a business with a very poor credit history).
A constant threat looms over small businesses that are denied loans as they remain on their credit file, and, depending on how many rejections, can impede their creditworthiness on future applications. Loan comparison sites’ key advantage is alleviating this concern as more information and options are presented.
Instant Loans for Startups – Pros and Cons of Quick Capital
Instant loans are all about rapid access to funds. Digital lenders have pioneered these loans and can sometimes get funds to an applicant within hours.
Pro – Fast Approval
Instant loans are perhaps the furthest possible experience away from bank loans. Instead of having several in-person meetings where business plans are drawn up and discussed, applicants head online, hand over minimal documentation (often bank statements), and the entire approval process is automated.
In fact, they’re so fast that they can act as a backup buffer that needn’t always be used. Being there when needed can allow the startup to take necessary risks with existing cash for growth.
Con – High Interest Rates
Because of the extensive application process for a bank loan, the lenders are more certain about the borrower’s risk. This means that bank loans are cheaper, but mostly because they rule out lenders with higher risk profiles.
Pro – A Second Chance
Instant loans have higher interest rates, but by not relying on credit scores and instead using AI to scan through the company’s financials, their risk assessment is still strong. This allows them to accept applicants that banks would not because they’re less interested in credit scores and more interested in their own streamlined checks of the financials.
Con – Shorter Repayments
Instant loans tend to have short terms of just a year or two. Though exceptions exist, these are generally geared towards startups needing to quickly soothe over cash flow difficulties rather than commit to long-term projects.
Pro – No Collateral
Keeping business and personal assets separate is essential for any business owner, and many new founders don’t have anything to use for collateral, even if they want to. Digital instant loans never ask for security, while banks often do.
Avoiding Common Loan Mistakes That Could Harm Your Startup
A common mistake is thinking that all lenders will view you identically; therefore, it doesn’t matter where you apply. This is dangerous because lenders not only have their own ways of assessing a borrower’s risk, but they also have different loan products.
For example, needing a new restaurant kitchen or building a home office are particular uses of a loan. Searching for lenders specializing in these types of loans will make them more accustomed to your situation and may offer lower rates.
Overborrowing is a common risk because access is so frictionless. There will always be asymmetric information where the borrower knows more than the lender. Therefore, it’s still your responsibility to be fully confident in your ability to repay – and relying on loans to repay other loans creates a debt trap that gets harder and harder to escape.
Conclusion – Financial Planning for Sustainable Business Growth
Businesses oftenneed debt to grow, and being under-geared is a concerning sign of not fulfilling potential. However, there is a stark difference between loan types, and using the right tool is important. Alternative lenders haven’t made traditional lenders redundant but have made them no longer complacent.
It is up to business owners to use the wealth of information online and the help of online comparison tools to find the right product for them. We know that more choice is better, and founders now have an extra resource to turn to in a time of urgency.
Image Credit: Photo by Austin Distel; Unsplash
