A number of startups turn to online lenders for their financing needs, which are often modest, yet they are the least satisfied with borrowing from these types of lenders, according to a report released Tuesday by the Federal Reserve Bank of New York.

And in weighing financing options, startups also tend to sort themselves by credit risk profile. Those with low credit risk had the most success applying to small banks for credit (78%), while medium- and high-credit-risk startups found the most success with online lenders (45%).

“What you see in this report is the traditional providers are still where firms are seeking financing, but there’s a bit of a sorting that’s going on with different risk-type firms,” said Claire Kramer Mills, assistant vice president and community affairs officer at the New York Fed.

“Going into this I would have said startups are applying to online lenders at higher rates. ... What was surprising to us was, if you’re medium or high credit risk, regardless of your [company's] age, you’re going to have a higher propensity to apply to an online provider than a low-risk firm.”

The report centered on the financing needs of startup firms, defined as those five years old or younger. The New York Fed surveyed more than 2,000 startups nationwide as part of a broader effort to learn about the credit needs of small businesses. Though startups are riskier from a credit perspective, they are also twice as likely as mature firms to add jobs and grow revenues, the report said.

The agency asked respondents to self-identify their credit risk, defining low credit risk as an 80 - 100 business credit score or a personal credit score of 720 or higher, and a medium to high credit risk as a 1 - 79 business score or a personal credit score below 720.

Slightly more than half of startups (52%) sought credit in 2016, compared with 42% of mature firms. Of those with financing needs, the majority of startups (63%) applied for less than $100,000, compared with 49% of mature firms. Just 31% of startups received the full amount of financing they applied for, compared with 46% of mature firms that received the full amount they wanted.

And startups do like their banks, especially community banks. Nearly half (48%) of startups responded that they were satisfied with small banks, compared with 31% that said the same for large banks and 23% for online lenders. Startups often felt neutral (40%) or dissatisfied (37%) with online lenders.

High interest rates were a common complaint about online lenders (32%), and with both large and small banks, startups cited difficult application processes and long waits for credit decisions. But startups’ main beef about any type of lender was a lack of transparency, the agency said.

“I think what was really interesting was how common lack of transparency registered irrespective of lender,” Mills said. “There’s been a lot of discussion about how you have these trade-offs if you’re a business borrower. Do you want to go for a better rate but maybe a longer waiting process? Or do you want the expediency of a fast credit decision and you’re willing to deal with higher borrowing costs?”

Startups most frequently sought a loan or line of credit (86%) over other financing options, although startups of all risk profiles sought out credit cards at higher rates than more mature firms. This is likely because startups tend to have uneven cash flows, and that points to a potential area of opportunity for banks, Mill said.

“I would say that there are opportunities for product development to help firms smooth cash flow, and I would also say there are opportunities to help firms establish and improve their credit scores,” she said.

Though startup businesses may be happier overall with banks, 27% told the New York Fed they were debt-averse and another 27% said they were discouraged from applying for financing.

Though the New York Fed did not ask the latter group whether that discouragement was based on perception or experience, Mills said: “I think a lot of these firms that identified as discouraged are rational about it. They know what their fundamentals are, they know their business performance was not great. They’ve got revenue challenges and profitability challenges, and they overall did look like they were higher risk.”

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