Why Half of U.S. Small Businesses Now Turn to Private Lenders

Over 50% of all small businesses in the United States are now securing financing through private lenders instead of traditional commercial banks. This shift is not just a trend; it reflects a changing financial landscape and the evolving needs of business owners. But what’s driving this remarkable change?

The answer lies in the fundamental differences between how banks and private lenders operate.

Understanding the Bank Lending Model

Banks function primarily as cash flow lenders. Because they are regulated by federal agencies such as the FDIC and the OCC, commercial banks must adhere to strict underwriting standards at all times. This includes requirements like demonstrating a minimum 1.25x debt service coverage ratio (DSCR). In short, if a business cannot provide documented, consistent cash flow that more than covers its debt obligations, banks are legally unable to approve the loan, regardless of the borrower’s collateral or growth potential.

As a result, many small businesses with promising prospects but inconsistent or undocumented cash flows find themselves unable to secure funding through traditional banking channels.

Why Private Lending Fills the Gap

In contrast, private lenders operate under a different model. They are collateral-based lenders, focusing on asset value rather than rigid cash flow metrics. The key considerations for a private lender are:

• Sufficient Collateral Coverage: Typically, this comes in the form of real estate or other tangible assets that back the loan.
• A Clear Exit Strategy: Lenders want to know how the borrower plans to repay the loan, whether through a refinance, asset sale, or another liquidity event.

This approach provides significantly more flexibility for borrowers, especially those with strong collateral but unconventional income streams.

The Banking Industry’s Private Lending Dilemma

Interestingly, many CEOs at major money center banks have begun exploring ways to enter the private lending market to stay competitive with established private lenders. However, their hands are tied. Any foray into private lending requires approvals from federal regulators, including the FDIC and OCC, and such approvals are hard-won and rare.

Insights from Experience

As the former President and CEO of a publicly traded community bank in Connecticut, I’ve experienced firsthand the extensive regulatory environment banks must navigate. These regulations, while essential for protecting depositors and the integrity of the financial system, inherently limit the agility of banks, especially when it comes to serving the nuanced and immediate needs of small businesses.

Private lenders, free from these restrictions, offer a more adaptable and solutions-driven approach. This gives them a distinct competitive advantage and allows them to serve a broader spectrum of borrowers while filling critical gaps in the lending marketplace.

A Smarter Path to Capital

For small business owners seeking fast, asset-backed financing with fewer regulatory hurdles, private lending offers a practical and effective alternative. At Worth Avenue Capital, we are committed to leveraging our deep industry knowledge and flexible underwriting approach to provide small and mid-sized businesses with the capital they need, when they need it most.