This post was written by Angela Angelovska-Wilson. 

There is no shortage of reports that indicate that small business financing has been one of the hardest hit segments during the financial crisis.  Specifically, the Cleveland Fed noted that in the years between 2007 and 2012, small business lending declined 78%.

Obviously, there is a myriad of reasons for the extreme drop in small business lending during the Great Recession.  Even today, traditional bank lenders see small businesses as less attractive and more risky borrowers than they used to be prior to the financial crisis. Fewer small business owners have the cash flow, credit scores, or collateral that bank lenders are looking for.  This gap has opened up an opportunity for non-bank, online financial services companies commonly referred to as “Alternative Lenders” that are aggressively pursuing many of the small business customers traditionally served by banks. 

Alternative Lenders rely on technology for receiving and processing applications and are mining Yelp, Facebook, Twitter and other social-media data to help identify a borrower, to determine a borrower’s creditworthiness and to quantify a borrower’s propensity to repay.  Typically the application process and the decision have a very quick turnaround, from just a few hours to only few days.   

Industry analysts have estimated that about two dozen Alternative Lenders — including OnDeck Capital Inc., Kabbage Inc. and CAN Capital Inc.— lent about $3 billion collectively in 2013, double the 2012 total.

Traditional bank lenders are taking note of this trend and are learning how to deploy technology in their own small business lending operations.  Even Fair Isaac Corp. has publicly stated that it is weighing possibilities for incorporating social media in credit scoring.  However the use of social media analytics is a trend that is raising serious concerns among consumer groups and regulators.

The alternative lending space is certainly heating up, more players are entering the market, existing companies are growing fast and investors are placing their bets.  Many of these companies could be interesting acquisition targets for traditional banks.  Most importantly, let’s not forget that traditional lenders have a clear-cut competitive advantage over Alternative Lenders – much lower cost of capital.  Of course, even Alternative Lenders are not without competition, today’s small business owners can also turn to crowdfunding, peer-to-peer lending, microlending, and other options for financing of their operations and dreams.