Business loans are sine qua non of running a successful enterprise. A recent industry study revealed that the most popular reason for borrowing was to meet working capital. Speed being crucial for such expenditure, it is no surprise that many small business owners preferred the much quicker unsecured credit line over traditional bank loans.
Here are some of the main reasons why small entrepreneurs choose unsecured business loans.
Banks associate small businesses with increased risk. They are unwilling to lend to entrepreneurs with sub-ideal credit scores. In fact, the interest rates charged by major banks are nearly 200 base points higher than those charged to larger enterprises. Unsecured loans, on the contrary, are available at interest rates that are customized to suit the borrower’s potential.
Limited access to equity capital:
There are few formal avenues wherein small businesses can avail equity funding. Most small business owners find it challenging to capture the attention of angel investors, venture capitalists or crowd-funding.
Securitization of loans:
Banks historically emphasize real estate as collateral. Banks are reluctant to accept intangible assets – like digital wealth, as collateral. Small businesses and tech start-ups find it easier to avail unsecured loans than to convince a bank to extend a loan to them.
Entrepreneurs who wish to purchase loan products from banks report that loan information is sparse. They cannot effectively compare between competing products. On the other hand, banks expect entrepreneurs to provide complete information. It could be a tedious process. Unsecured loans are available through highly simplified online applications.
Banks take, on average, four to six weeks to approve a loan. Small enterprises are subject to vagaries of economic conditions. They rarely have the luxury of this much time. Unsecured loans can be approved and obtained in 1 to 5 days (some companies even offer same-day loans).
Unfavorable payment conditions:
Small businesses are pinched on both ends when it comes to payments. Supplier Payment Codes bind them to pay within 30 days. But, large businesses which aren’t signatories to the Code take longer than 30 days to make payments. The situation drives entrepreneurs to relatively quick unsecured financing.
Larger businesses have well-established networks. They can avail cost-effective alternative lending from within their network on quid-pro-quo terms. Small businesses and start-ups rarely have this benefit at the stage they are currently in.
Limited financial capability:
The Australian Small Businesses and Family Enterprises Ombudsman reported that up to 45% of small businesses do not use accountancy software. Additionally, entrepreneurs are usually unaware of how credit scores are calculated. They need to be educated on what actions can improve or deteriorate their score.
Operational benefits of unsecured business loans:
Apart from ease of availing the loan, there are other advantages, such as: (i) The credit lines are opened immediately on approval of the loan. (ii) Entrepreneurs can choose to repay in full, without attracting penalty, sometimes attracting discounts. (iii) Interest is paid only on the amount used. This is not the case in secured loans, where interest needs to be paid on the entire loan amount, irrespective of whether it has been used or not. (v) As each customer is unique, repayment options are flexible. They are tailor-made to the needs of the borrower.
Thus, there is an expanding demand for unsecured loans in Australia. The Reserve Bank has engaged with non-bank loan providers to understand their challenges – such as high costs of lending. With appropriate policy measures, unsecured business lending is sure to constitute a larger share of business loans in the future.