Sad fact is: most banks don’t like to do car wash financing. In fact, whether it is bank financing, SBA guarantees, or private financing, most car washes are considered “special facilities” and funding is often difficult. Fortunately, hundreds of millions of dollars are being raised from unique new, online “platforms” such as crowdfunding, peer-to-peer lending, and marketplace lending.
Crowdfunding, for instance, employs an online platform to raise small amounts of money for projects or ventures from a large number of people and recently entered the equity arena. Peer-to-peer lending is the practice of matching borrowers and lenders through other online platforms. And, while the newer “marketplace” funding remains largely undefined, it encompasses lenders that make loans to higher-risk, lower-income borrowers; micro-finance; and larger-scale lenders that market their products to traditional consumers and small businesses.
Bottom line, the entire lending marketplace is an emerging segment of the financial services industry that increasingly uses online platforms to lend directly or indirectly to consumers and small businesses. Borrowers are able to gain access to funds quickly and typically at lower interest rates than offered by many banks, making it an attractive loan alternative for borrowers. How can a car wash operator or investor take advantage of these speedy financing options while avoiding the risks associated with borrowing from so-called “shadow banks?”
CROWDFUNDING GROWING FAST
Crowdfunding “platforms” are known for raising money for worthy causes and special projects. Popular platforms including Kickstarter, Indiegogo, and Crowdrise provide this so-called “reward” crowdfunding and, more recently, equity crowdfunding and debt crowdfunding.
Today, crowdfunding is challenging venture capital and angel funding as an alternative source of financing for many small businesses. Equity-based platforms provide backers with shares of the business in exchange for the money pledged. In fact, thanks to the Jumpstart Our Business Startups (JOBS) Act of 2012, small businesses can now raise more funds from small investors with fewer restrictions, thus creating more interest in crowdfunding.
Businesses just starting out or in their early stages can pitch an idea to ordinary people, as well as wealthy investors who might be interested in investing small amounts of money. In exchange, the business owner offers some small incentive to donors (e.g., a free T-shirt) or a larger incentive (e.g., equity in the car wash operation or business).
The new Securities and Exchange Commission (SEC) rules allow businesses, even first-time start-ups, to raise up to $1 million online from non-accredited investors over 12 months. The compliance usually required in private fundraising is waived although borrowers must provide financial statements — statements that don’t have to be audited.
The amount an investor can invest via crowdfunding depends on their income. According to the SEC, an investor with an annual income and net worth of less than $100,000, can invest $2,000, or 5 percent of their net worth, whichever is greater, during a 12-month period. An investor with annual income or a net worth equal to or more than $100,000, can invest 10 percent of their annual income or net worth, whichever is greater.
The crowdfunding sites, not the borrowing business, must be registered with both the SEC and the Financail Industry Regulatory Authority (FINRA). Debt crowdfunding, borrowing from individuals and other organizations, has also grown rapidly and moved into its own category, often referred to as peer-to-peer (P2P) lending.
As borrowers seek alternatives to traditional bank lending, so-called “peer-to-peer” or P2P lending is growing rapidly. Much like crowdfunding, P2P lending matches borrowers and lenders through an online platform. P2P borrowers are able to gain access to funds quickly and often at lower interest rates than offered by banks, making it an attractive alternative to more conventional bank loans. The loans issued comprise funds from many different investors ranging from individuals to institutions. P2P lenders underwrite the borrowers but don’t fund the loans directly — they’re an intermediary between the borrowing business and institutional investors such as hedge funds and investment banks. Those third-party investors invest in the loans through the online P2P marketplaces, and assume all investment risk, not the P2P lenders.
Individual and professional investors benefit by being able to lend money at a range of interest rates based on proprietary credit scores assigned by each P2P lender’s platform. Since investors typically fund only a portion of a loan and spread the amount they loan across many borrowers, investors can potentially receive steady, attractive returns with the risk spread among multiple borrowers.
As a borrower, the car wash or detailing business only interacts with the P2P lender. After investors agree to fund the loan, the P2P lender transfers the total loan amount into the borrower’s bank account. The business/borrower repays the P2P lender, and they deal with repaying the investors.
Unfortunately, even though it may be the most innovative source of funding, P2P lending is usually not the most affordable. Admittedly, banks take a lot longer to issue loans than do P2P sites, but a car wash operator or investor that can wait and that can qualify for a traditional bank loan or an SBA loan, will find that to be a far less expensive option -– if available.
As a more diversified set of investors, especially institutional investors, become involved on lending platforms, “marketplace lending” is becoming far more popular. Online “marketplace” lending refers to the segment of the financial services industry that uses investment capital and data-driven online platforms to lend directly to small businesses and consumers. While the volume is tiny in comparison with traditional bank lending, marketplace lending is experiencing rapid growth, with new lenders originating over $12 billion in loans.
Marketplace lenders employ new, largely automated underwriting processes. Some lenders purport to rely on “big data,” often overlooked as part of traditional bank underwriting processes. However, there has yet to be one consistent, concise definition of what marketplace lending truly means. The U.S Treasury has issued a rather broad definition for “marketplace lending,” stating that it is: “the segment of the financial services industry that uses investment capital and data-driven online platforms to lend either directly or indirectly to small businesses and consumers.” They go on to say: “Companies operating in this industry tend to fall into three general categories: (1) balance sheet lenders, (2) online platforms (formerly known as “peer to peer” or “P2P”), and (3) bank-affiliated online lenders.”
In general, marketplace lenders can be described concisely in three parts: a non-banking financial institution that heavily leverages technology to drive simplicity and speed of process and serves a two-sided market of consumers and investors.
The majority of alternative online lenders lack a brick-and-mortar presence with which to interact with their customers making it important for borrowers to spend time differentiating models. As mentioned, each “type” of “marketplace lender” has a differing business model with varying revenue streams and diverse motivations in serving their customers.
Marketplace lenders are currently required to comply with federal consumer financial protection laws such as the Truth in Lending Act, Equal Credit Opportunity Act, Fair Debt Collection Practices Act, and Gramm-Leach-Bliley Act. Peer-to-peer lenders that fund loans through third-party investors (rather than from their own balance sheets) may also be subject to securities regulation.
For the most part, however, marketplace lenders are not subject to comprehensive federal or state supervision and examination in the same way as are banks and other insured depository institutions, nor are they subject to safety and soundness regulations, including minimum capital and liquidity requirements, under federal law.
In fact, many marketplace lenders rely on banks to originate loans and merely purchase those loans for resale to platform investors. Therefore, for these lenders, a borrower may indirectly receive the same regulatory protections as any bank customer. In addition, a marketplace lender acting as a service provider to one or more banks may be examined by bank regulatory agencies in connection with the services provided to the bank.
TRADITIONAL VS. ALTERNATIVE FUNDING
Bank loans continue to dominate the financing space for small and mid-size businesses in need of capital. It is important to keep in mind that these new online entities are generally not government regulated in the way banks are. While it creates potentially more risk, it also makes them potentially more nimble, enables them to operate at lower costs by not having to follow all of the same compliance and regulatory requirements and to innovate with technology at its core.
Crowdfunding, peer-to-peer loans, and the more closely-related marketplace loans offer an often less expensive source for the funds needed by a car wash investor or business and are usually much faster than funding from a more conventional bank or financial institution. Regulation and oversight of these alternative funding sources remain a concern for investors although both are on the upswing. Deciding which alternative will benefit your business and be less costly may require the services of a loan broker or other qualified professional. At the very least, all options should be thoroughly researched.
Will your car wash business benefit from the alternative funding available from the online lending platforms?
Mark E. Battersby is an Ardmore, PA-based freelance writer, specializing in finance and tax issues.