KEY POINTS

  • Small businesses are the backbone of the US economy. Small businesses represent 99% of US companies, 54% of total sales, and 55% of all jobs, according to the US Small Business Administration
  • But small businesses are woefully underfunded and have trouble getting loans from traditional lenders. As of late 2015, only 49% of businesses with $100,000 to $1 million in annual revenue that applied for financing received loans from large banks. We estimate that there was $96.5 billion of unfulfilled small business loan demand in the US in Q4 2015.  
  • Alternative lending platforms are in a position to capitalize on this underfunding and also take share from banks. These companies use machine learning and digital tools to extend credit to a wide array of small businesses quickly and efficiently. We estimate that alternative lending companies' share of the small business lending market in the US will reach 20.7% by 2020.
  • Alternative lenders are now partnering with banks and this will propel growth going forward. New lenders are finding opportunities to offer white-label services to major banks. We expect banking partnerships, like the one between JPMorgan and OnDeck, to add 7.7 percentage points to the alternative lending industry's market share by 2020. 
  • There are four main types of alternative lending companies: balance sheet lenders, marketplace lenders, aggregators, and hybrid lenders. Balance sheet lenders earn interest off the loans they issue. Nonbalance sheet lenders, meanwhile, charge origination fees when customers use their platform, and do not collect any interest on the loan.
  • A flurry of new lenders have entered the market, but it's still early innings. A handful of small business lenders, from Funding Circle to Credibly, have entered the market and this is creating challenges as customer acquisition costs rise and alternative lending companies struggle to differentiate themselves.
  • There are some key risks for these new businesses going forward. Sky-high interest rates suggest alternative lenders are targeting too many high-risk borrowers. OnDeck, for example, charged a weighted average 69% APR to its borrowers in 2012, dropping to 41% by the end of 2015. We expect that some of these new entrants will fail as unproven risk models result in borrower defaults. 

The Small Business Lending Market

Small businesses are the backbone of the US economy. Small businesses — businesses with less than 500 employees — represent 99% of US companies, 54% of total sales, and [...]