The traditional bank model for small business lending is broken. As a result, technology-enabled alternatives have gained momentum over the past couple years to provide small business owners with loan options that better suit their needs.
This emerging sector is creating exciting new opportunities for both small businesses and potential lenders, and payments companies are in a prime position to take advantage.
The U.S.'s 28.7 million small businesses are a critical part of the economy. They create two out of every three net new jobs and employ half of the private sector workforce. According to the Small Business Administration, more than 80% of these small businesses use some sort of financing to grow their business.
Access to loans is absolutely essential for small businesses to thrive. Working capital helps them maintain cash flow, hire new employees, purchase new inventory or equipment, and do whatever else is required to grow their business. However, access to small business loans has been increasingly difficult to find over the past few years.
According to Karen Gorden Mills, a Senior Fellow at Harvard Business School and former Administrator of the U.S. Small Business Administration, the banking industry in the aggregate appears increasingly less focused on small business lending. Mills, who published a working paper in 2014 that explored the availability of bank capital for small businesses, found that small businesses are currently struggling to find loans and bankers are saying that it is difficult to find creditworthy borrowers.
Mills identifies the most recent recession as a major culprit, due to the ensuing increases in regulatory oversight, higher compliance costs, and heightened wariness over softer underwriting criteria. As a result, small business lending is drying up.
Many available bank loans are no less than $250,000 because each loan requires the bank to undergo a manual underwriting process that takes up a significant amount of time. However, most small businesses need closer to the $50K-$100K range. The smaller loans that are available generally offer interest rates of more than 75%, which small business owners are understandably reluctant to pay.
However when talking about a small loan for a small business, the lender is really underwriting a human. This means they can look at personal credit bureau information to make decisions. This type of information is available in the U.S., but difficult to access (or virtually non-existent abroad).
The credit crunch, in addition to the growth of the online lending sector and advancements in Big Data, has led alternative lenders to come up with new, data-driven, innovative ways to evaluate potential borrowers. Data is the key to doing this effectively and payments providers have some of the greatest access to personal financial information.
These companies have unique data on how many transactions a business is doing, its cash flow, and other valuable information that gives them unparalleled insight into its viability. Access to this data also reduces risk because it strengthens a payments companys ability to avoid default and weed out potentially bad loan prospects. In addition, it enables them to carry out the underwriting process much faster than financial institutions.
Another benefit to payment providers serving as lenders is their ability to create more flexible repayment options. Instead of repaying a loan in monthly installments, merchants could pay 10% of their transaction volume to the payment company until the loan is paid off. The lender is able to keep in close touch with the borrower, and the borrower is able to access funds in the way that best addresses their unique needs.
Payment providers already go through many of the processes that traditional lenders go through and assume some degree of risk. For example, if a business sells $100,000 worth of inventory, but never ships anything and goes out of business, the payment provider is on the hook for that. Payment providers are also accustomed to navigating financial regulation and compliance issues. So much of the infrastructure needed to become a lender is already in place, which makes the step to the small business lending a small one for payments companies.
The step may be small, but it is also vital. Small business owners need access to working capital in smaller and more flexible amounts than is currently available to them through traditional means. On the other end of equation stand payments companies, which have a wealth of relationships with and data about small business owners at their disposal that can be used to forge a more symbiotic, productive lending channel. SMB owners benefit from the ability to get the money they need and payment providers benefit from offering low-risk, high-rate loans.
Shawn Budde is CEO of 2Checkout.