What is microlending? Accessible funding alternatives for small businesses

Imagine you’re a small business owner or an entrepreneur trying to launch a startup. Securing a traditional loan isn’t always easy, especially when you're only looking for, say, $50,000 or less to keep up your momentum. Most lenders won’t give out loans below that amount.

This is where microlending comes in. Microlenders provide smaller loans to businesses that can’t necessarily find traditional sources of funding.

In this article, we define what microloans are, explain how they work, identify who they benefit, outline the pros and cons, and provide guidance on finding reputable microlending partners.

What is microlending?

Microlending is a financing option that provides small amounts of money, known as microloans, to people or businesses who lack access to traditional banking and financial services.

Microloans are typically less than $50,000 and are often provided by government agencies, microlending platforms, and nonprofit organizations. They often target specific communities or demographic groups, like women, low-income individuals, immigrants, and other traditionally underserved communities.

To support these individuals in their ventures, microloan providers may offer affordable interest rates and reasonable loan terms. Once they receive the funds, borrowers use them to start or expand their business. They’re typically required to pay back the loan amount in installments with interest until the debt is fully repaid.

It’s easy to confuse microlending with microfinance. Microfinance is a broader concept that involves providing financial services, like savings accounts and insurance, to lower-income individuals or groups who don’t usually have access to traditional financial services. Microlending is a component of microfinance that focuses specifically on loans.

How microlending works

To take out a microloan, you must first find the right microlender for your business, fill out an application, sign your loan agreement that outlines the terms and schedule, and begin repayment once you’ve received the funds.

Borrowers, lenders, and platforms each play a role in microlending. Here’s how:

• Borrowers: These are the applicants and recipients of the microloans. They are responsible for repaying the loan once approved, within the agreed-upon terms. Borrowers benefit, as access to capital can improve their business prospects.
• Lenders: This includes peer-to-peer financing, where individuals or groups lend money directly to borrowers via online platforms, as well as institutional lenders such as microfinance institutions and NGOs. Often, they are motivated by social impact goals and the potential financial return on the loan with interest.
• Microlending platforms: Platforms serve as the go-between for lenders and borrowers, streamlining the process. They provide borrowers with easier access to loans and lenders with investment opportunities. The platforms themselves benefit by charging both groups fees to participate.

Typically, microloans range from $500–$50,000. According to the Small Business Administration, the average loan is $13,000. Interest rates can vary based on creditworthiness and range from 6.5%–15%. Repayment terms can range from a few months to several years, but generally are 1–6 years.

Borrower qualifications

Microloan lenders and microlending platforms review eligibility criteria for potential borrowers, which may include:

• Creditworthiness
• Demographics
• Size of business
• Time in business
• Cash flow projections
• Potential collateral or guarantees
• A strong business plan
• Location of business

Small business owners may seek out microloans for a variety of reasons, like:

• Launching a new business or initiative
• Challenges to accessing traditional funding
• Building credit history
• New marketing or advertising campaigns
• Purchasing new equipment to improve business operations

Application and approval process

The typical microloan application process starts with selecting a lender or platform that’s right for your business, demographics, or location. Once you’ve chosen an approved lender, follow these steps:

1. Review requirements and criteria
2. Gather necessary application materials and documentation
3. Fill out the application
4. Submit your application to the lender for review
5. Once approved, sign the final documents
6. Receive the funds

The actual timeline from applications to receiving funds varies based on your lender. You should consult with the lender or review the online documentation in advance to know what to expect, but the typical timeline is 30–90 days.

Types of microlending models

There are two different models of microlenders: peer-to-peer and institutional lenders. Both provide microloans to businesses that traditionally struggle to access traditional funding, but they differ in their approach.

Peer-to-peer financing connects microloan lenders directly to borrowers through online platforms, bypassing larger financial institutions. The platform assesses the borrower’s credit, and then lenders can decide to fund part or all of the requested loan

Institutional lenders are often nonprofits or government programs that target specific demographics, including lower-income individuals who are unable to work with traditional financial institutions for various reasons. These groups also offer financial literacy and training programs to help businesses succeed.

On a global scale, there are also programs and institutions that focus on serving developing countries. These groups aim to help alleviate poverty and promote financial inclusivity for groups that may face greater challenges in securing funding for their businesses in these areas.

Who benefits from microlending?

Much like traditional bank loans, small businesses can utilize microloans to fund their business operations, pay employees, purchase equipment, replenish inventory, and more.

These are a few of the groups that benefit most from microlending:

• Small business owners: Most banks avoid offering loans of less than $50,000, since they make less of a profit on them. And fewer small business owners can close smaller financing gaps on their own with home loans, corporate cards, and other alternatives. Microloans help small business owners cover these revenue gaps without resorting to predatory lending methods that can stifle cash flow in the long term.
• Startups: Many startups struggle to secure traditional financing, especially in the early stages. Microlending provides a lifeline for companies with limited capital.
• Underserved populations: Because minority-owned small businesses have historically received fewer funds or resources than their counterparts, some nonprofit organizations focus their lending efforts on underrepresented or low-income small business owners. Many of these microloan providers also offer additional resources to help their businesses thrive.
• Companies with bad credit: Many small business owners seeking financing encounter barriers due to poor personal or business credit. Microlenders aim to assist these businesses with their funding efforts, although they may impose additional loan requirements to mitigate their risk.

Microlending serves groups that have traditionally been excluded from traditional financial services. In doing so, it helps close the gap for businesses that might otherwise struggle to get off the ground, supporting both economic development and financial inclusion.

It also provides an opportunity for philanthropic leaders and social impact investors looking to promote social change while also generating revenue.

Pros and cons of microlending

Like any other type of business financing, microlending comes with its fair share of advantages and disadvantages. Let’s take a look at some of the pros and cons of microloans for borrowers and lenders:

Benefits for borrowers

• Easier qualifications: Traditional lenders typically require strong business and personal credit scores, a low debt-to-income ratio, minimum annual and monthly revenue thresholds, and loan collateral. In comparison, you don’t need the best credit score or the most impressive business plan to receive a microloan.
• Smaller loan amounts: Larger banks often will not consider loans less than $50,000. But with microlending, you can receive smaller, more manageable loans that are more easily repaid and give your business the quick boost it needs.
• Flexible terms: When selecting your lender, you also have the option to choose the terms of your loan. Repayment terms can vary from a few months to several years, depending on your needs.
• Community support: Depending on the provider, you may get access to business education and training, marketing and sales support, networking opportunities, and more. Some microloan lenders will also report your repayments to one of the commercial credit bureaus, such as Equifax, Experian, and Dun & Bradstreet, which can help build business credit and give you access to better financial products later on.

Drawbacks and risks for borrowers

• Higher interest rates: Because microloans are much more accessible than their traditional counterparts, providers attract applicants who are far too risky for banks and other lenders. To offset these risks, microlenders may charge higher interest loan repayment rates on their products. As a result, borrowers may spend more money repaying the debt than they would with other financing methods.
• Shorter repayment periods: While flexibility of repayment terms is usually a pro for borrowers, the shorter repayment period may be a con, depending on what you need the money for. Microlenders are seeking a quicker return on investment, typically within 1–5 years.
• Risk of over-borrowing: Because microloans are for smaller amounts, there’s a risk of borrowing more than you need. This can lead to additional stress from debt and repayment. It’s best to carefully consider what you need so you don’t get in over your head.
• Personal assets as collateral: Many financial institutions reduce their risk by securing assets as collateral. This is a practice some microlenders have picked up as well. You’ll want to know up front if a lender will require collateral and decide whether it’s worth it to put up something as valuable as your home as collateral.

Considerations for investors

Lenders should also carefully consider microlending. These are a few factors to think about before investing:

• Potential for social impact: Since microlending is often targeted at groups, like women, people of color, and lower-income individuals, it can help investors achieve their social impact goals and promote greater financial inclusivity in small businesses.
• Risk of default: Microlending is a benefit for borrowers with limited financial history and lower credit ratings, but that comes with a higher risk of default and losses to investors.
• Expected returns: However, when everything works out as planned, investors can expect returns more quickly than with traditional loans, making their investment worthwhile.

Top microlending organizations and platforms

Advancements in technology have led to the rise of more microlending organizations and platforms. While not an exhaustive list, here are some of the top microlenders to consider:

• Kiva: Kiva is a nonprofit that uses a crowdfunding model to provide loans of up to $15,000 with 0% interest. Kiva employs a concept it calls “social underwriting.” After a prospective borrower’s initial application is approved, they have 15 days to recruit lenders as an endorsement of their character and creditworthiness, after which the borrower can appeal for funds from the entirety of Kiva’s investor network for 30 days.
• Accion Opportunity Fund: The Accion Opportunity Fund grants small business loans from $5,000 up to $100,000, particularly for businesses owned by women, people of color, and immigrants. The nonprofit provides loans to applicants with Individual Taxpayer Identification Numbers (ITINs) and offers educational resources, personalized coaching opportunities, and support networks for borrowers in English and Spanish.
• Grameen America: Grameen America offers microloans starting at $2,000 to women entrepreneurs who live below the federal poverty line. Approved applicants form groups with four other women they trust, open a free savings account at a commercial bank, and receive extensive financial training. They receive additional financial education and support while helping to build their credit profile.
• LendingClub: LendingClub partners with the Accion Opportunity Fund to lend to small businesses. Loans have fixed monthly payments with terms ranging from one to five years. They also provide dedicated advisors for any of your other business needs.
• SBA Microloan Program: The Small Business Administration (SBA) offers microloans of up to $50,000 for new and expanding small businesses, which can be used for various purposes, including working capital, equipment, inventory, supplies, and machinery. The federal agency collaborates with several approved nonprofit lenders nationwide to administer these loans. Since lenders handle much of the process themselves, they’re also allowed to set their own lending and credit criteria for borrowers.

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