Economy Matters

May 16, 2019

Online lenders occupy a growing slice of the small business market, as an increasing share of firms turn to them to meet financing needs, an annual Federal Reserve report shows.

Nationally, 32 percent of small business credit applicants approached online companies in 2018, according to the 2019 Small Business Credit Survey: Report on Employer Firms. That share is up from 24 percent in 2017 and 19 percent in 2016.

State-level data included with the national report show the extent to which small companies in the Atlanta Fed’s district sought funding from online lenders. Of small business applicants in Florida and Georgia, 40 percent chose online lenders as a potential financing source, compared with 30 percent of small business applicants in Louisiana and 22 percent in Alabama, the survey shows.

Digital lending access assumes greater significance

“Online lenders are becoming increasingly important to small businesses,” said Mels de Zeeuw, a senior research analyst in the Community and Economic Development group at the Atlanta Fed. The speed with which online lenders process applications—borrowers can receive approval in hours or even minutes—helps explain why small firms increasingly seek them out, he said. Also, online lenders can offer a greater chance of receiving funds (for example, by using different decision making criteria), and they can require lighter collateral assurances compared with traditional banks.

The Atlanta Fed's Mels de Zeeuw. Photo by David Fine

Online lenders typically offer products such as cash advances, lines of credit, and various types of loans. They include companies that raise money and directly lend, market platforms that connect small firms with investors, and payment processing firms. A 2018 study published by the Federal Reserve states that industry analysts estimate the volume of online lending to small business to have been about $12 billion in 2017.

However, trade-offs accompany the use of online lenders. Small firms in the latest credit survey said they faced higher interest rates and more unfavorable repayment terms when doing business with those companies. De Zeeuw also said companies that apply to online lenders tend to have lower credit scores. “They could be filling a need for certain riskier applicants,” de Zeeuw added.

Traditional banks, large and small, still have a big role

Even with the growing role of online lenders, banks attracted more applications from small firms last year, the report shows. Forty-nine percent of small business applicants nationwide sought financing from big banks and 44 percent of applicants went to small banks. (Some firms approached multiple lenders simultaneously.) The survey data bear this out for the Southeast as well. In Georgia, 52 percent of applicants turned to small banks, 47 percent went to large banks, and 40 percent of applicants used online lenders. In Florida, 65 percent of small business applicants sought financing from large banks, 36 percent from small banks, and 40 percent from online lenders, the survey showed. In Alabama, 26 percent of applicants went to large banks, 62 percent to small banks, and just 22 percent to online lenders.

The credit survey, which provides an annual read on the health of businesses that have as many as 499 full- or part-time payroll workers, found that small firms saw stronger revenue and employment growth last year, benefiting from the strong U.S. economy.

Even so, survey results indicate that challenges—such as rising overhead expenses, tight credit availability, and debt repayment—might be on the horizon for small businesses. Further, the rising costs of materials and labor are a factor (see the tables). A large majority of firms (73 percent) noted that their input costs increased in the past year. Additionally, the share of companies that expect to hire workers this year is 44 percent, down from 48 percent that anticipated adding employees in 2018. That finding “could reflect the tightening of the labor market and the difficulty that small businesses in particular face in hiring workers,” de Zeeuw noted.

In the Southeast, however, firms appear to be more optimistic about hiring, with 53 percent of small businesses in Florida and 55 percent in Georgia expecting to increase their employment, according to survey results.

Karen Jacobs

Staff writer for Economy Matters