True story: Backed by a loyal following, a Colorado natural foods company set out to grow from a regional success to a national brand. But despite the consumer excitement around its products, the company struggled to access the capital it needed to grow. As a pre-profit startup, it lacked the track record necessary to get an affordable loan.
This isn’t a unique story. Around 90 percent of startups fail to meet their initial financial goals. It’s often challenging, if not impossible, for a pre-profit company to receive the capital needed to sustain the first few hard years of growth and escape the precarious grey space that separates bootstrapped startup from capitalized company. After the 2008 recession, it became even more difficult for early-stage companies to receive traditional financing from banks and venture capital firms. Risk-averse investors still feel the sting of past losses and demand more evidence of strong returns, leading to the exclusive pursuit of more mature companies.
It’s hard for the lenders, too. Because bank portfolios are heavily scrutinized by federal and state regulators, banks can’t typically finance pre-profit companies; these companies are deemed too risky, even if they show impressive early-stage growth.
In the absence of traditional capital infusions, social entrepreneurs seeking initial loans of amounts ranging from thousands of dollars to the single-digit millions are often lured to less reliable — and more expensive — modes of financing, from maxed-out credit cards to second mortgages on their homes. Larger early-stage companies often turn to a patchwork of other funding options, from pricey online lenders to crowdfunding, to finance their growth. All totaled, entrepreneurs give up an average 25 percent of their pre-profit companies to investors, on the off chance of making it past early-stage development obstacles.
Growing companies already face enough challenges, and this early-stage funding gap only makes it worse. Given current market realities, how can banks and other providers serve these companies while still mitigating financial risk?
Fintech lends a hand, but only to a point
A rising class of tools is emerging in the post-recession marketplace to help young companies access early-stage funding and other financial services.
Today, more startups seek financing through financial technology (fintech) platforms that provide new ways to finance, while leveraging web services and data-driven automation in an attempt to level the playing field and disrupt the traditional lending market.
Fintech exploded into a multimillion-dollar industry over the past decade, with more growth on the horizon, largely by addressing inefficient and exclusive financial traditions. Rather relying on financial advisors, for example, these companies may turn to automated advisory systems that use algorithms to generate specific financial advice. Fintech companies used services like these to disrupt not only early-stage business financing, but also the student loan, online lending, and mobile payment industries.
In the case of small businesses, fintech offers innovative solutions that increase access to VC investments and bank loans, but this new market hasn’t completely solved the financing woes for pre-profit companies. Fintech options are still relatively expensive, with capital typically ranging from 15 percent to 25 percent, meaning that a cheap source of funding remains relatively unattainable for young companies.
Closing the early-stage finance gap
If not fintech, traditional bank loans, or crowdfunding, what is the best answer for early-growth companies looking to jumpstart their financing opportunities? How can we learn from the best of each of these systems and create a comprehensive solution?
Remember that natural foods company? It was among the first to pilot a new offering from New Resource Bank and P2BI, a fintech asset-based lender. Called Catalyst Credit Line, the program aims to make affordable bank loans available to early-stage companies while minimizing maintenance needs and risk. A collaborative funding mechanism balances investment between the bank and a select pool of accredited investors, who can engage with early-stage companies via an online platform. This allows for lower interest rates than traditional asset-based lending and gives companies access to both qualified investors and the secure backing of a bank.
This marriage of a fintech and a banking solution is part of a broader trend. Companies are beginning to realize they can combine traditional banking, the cloud, and crowdfunding to offer new forms of financing through which everyone wins. True innovation takes place from the bottom up, and making success possible for pre-profit companies with great ideas opens the door for big potential.