Should You Invest in Small Business Loans? The Small Business Bonds Marketplace (SMBX) Full Review
The Small Business Bond Marketplace (SMBX?) is a site that's recently popped up that uses the JOBS Act to allow everyday investors to loan out money to small businesses. The site has been growing in prominence recently, and so I decided to take a look at it. Small businesses come to SMBX with the intention of getting a loan and then define the terms of the loan. Right now, the loans are typically 6–9% for 2–5 years, but I’ve seen loans as high as 10 years. From the investor's side of things, it’s very simple. You give them money then once the offering ends, you begin receiving payments on the loan the very next month. The money goes to a balance on the SMBX website, then you can withdraw it once you see fit.
In theory, it sounds like a pretty good deal and even a good way to get passive income. However, once you take a closer look, that might not be the case. Here’s a full video (Don’t forget to subscribe!)
So, before I get started, I did reach out to their support and ask them what the default rate for the businesses on their site was, and if they have had any defaults yet. I tried asking in several different ways to get any indication of their default rate, and they did not answer in any way. They just said, “We’re not releasing that information at this time.” I don’t know why they wouldn’t answer that question because that’s realistically one of the most important questions to consider when making consistent loans. If they have a higher default rate then the overall industry then that would favor them heavily in this analysis. However, not answering it is a bit suspicious, as it’s such vital information for their model.
This means I will be using the default rates for the Small Business Administration, which is considered the “gold” standard for small business loans. These are low-interest loans that are not guaranteed, and the process is long and thorough. The current rates are similar to SMBX currently sitting at between 5–8% and tend to be long-term loans (As much as 10 years).
The default rates, even for the best of the best companies, are between 11–25% default rates. This shows 1 in 4 defaulted during the 2008 recession and tends to average around 1 in 6 default on the loans. Even though we’re starting to head into a market downturn, and loan default rates are probably going to start getting worse, I am still going to use the 1 in 6 default rate for these calculations.
It’s important to note before we begin these are amortized loans as well. So, if you see an 8% yearly interest rate, it’s 8% on the remaining balance. So if you loan $1000 at an 8% yearly rate, you get $1,080 paid back. If it’s an 8% amortized loan for $1000, then you’ll get $1,043.86 paid back. This is because once they make the first payment of, say, $100, then they only pay back 8% on $906 ($1000 + Interest accrued of roughly $6 then subtract the $100 payment).
So, using this information, let's take the average terms for many of these deals:
12 loans for $1000 each
8% APY Amortized
5-year loan terms
This is the current list of companies you can loan money to, and these terms are on the favorable end of those as well.
In a best-case scenario, if all 12 pay back 100% of their loans, you’re looking at a return of:
$2,599.00 interest over 5 years.
Meaning: $12,000 → $14,599
A yearly ROI of 4% per year, or 21.66% over 5 years.
And the good thing about this is the fact that they are paying you every month. This means you don’t have to wait the full 5 years to get your money back… but the downside is the return just isn’t that great. More importantly, this is extremely unrealistic because this is assuming a 0% default rate on 12 loans.
So, the absolute MOST you could make is 4% ROI assuming the absolute BEST case scenario, using the gold standard for loan default rates. Which is underperforming nearly every asset class in the world.
Now, let’s take a look at the loans when they start defaulting. Now, it’s important to note that no loan will default instantly. Likely it will be after about a year once they have used all the money and they can’t get more financing, and then they will go out of business. So, I will just factor in each default by paying down 50% of their loan before defaulting. Here’s the chart:
Again, these are giving them a MASSIVE benefit of the doubt. This is assuming that they have similar default rates to the Small Business Administration (which is EXTREMELY favorable to SMBX) and that all of the companies that default pay back HALF of their loan. So, if you loan out your money to these people for 5 years, and all of those that default paid back half of their loan, and 33% default then you would have lost about $470 over the course of 5 years… by loaning out money.
However, if 8–25% default, then you are technically still in the green, but barely. At a 25% default rate (which was during the 2008 recession, and we ARE in a recession right now) then you make less than 1% a year on your money. You would be losing money to inflation at this point. At the average, and expected, 1 in 6 default rate, then you would be making just under 2% ROI and a total of 8.89% over 5 years.
The Verdict — Is SMBX a Good Investment?
As always, I am not going to tell you what to do with your money, but this is definitely something I am staying away from. However, if you put your money here, then you are putting your money into something that is extremely high risk, with very little (if any) reward. All of these calculations are incredibly favorable to SMBX because odds are, they are going to have a worse default rate than the Small Business Administration. According to Investopedia, 20% fail in the first two years and 45% in the first five years, so you could be looking at default rates as much as 50% and only 1–2 years of payment. Not to mention, the current MAXIMUM ROI based on these calculations is 4%, so it’s just not great all around.