According to the U.S. Census Bureau, U.S. entrepreneurs will be filing 5 million new business applications per year starting in 2021. And in 2023, the number of new small business start-ups is growing by about 9% year over year, indicating that the growth of the small business sector shows no signs of slowing. This creates a huge opportunity for fintech lenders.
When small businesses seek financing, they often turn first to deposit-deposit banks, which is understandable given the trust relationships already established.
Additionally, depository banks have a wealth of data on small businesses, which allows them to conduct outbound marketing: Bankers can predict loan needs before small business owners do, making the process smoother as loans move through the system.
But fintechs have an opportunity to approach SMEs from a different angle, and the best way to do this is by offering a better lending experience, including easier application processes, faster decision-making and funding, and more flexible credit boxes that allow for the approval of candidates who would otherwise be rejected by deposit-taking banks.
From equipment loans to working capital lines of credit, there is a huge opportunity in the small business market, but fintech lenders must play it safe and use the latest technology and methods to conduct due diligence. According to trend data from Equifax Commercial, small business default rates have increased for 18 consecutive months as of February 2024. Lenders need the best information available to pursue high volumes of loans that fit their risk parameters.
Rapidly evolving technology tools
To improve customer experience while managing risk, they must leverage technology. Fortunately, fintech lenders have more data and analytical resources at their disposal than ever before. These tools help them better identify quality leads and securely qualify and onboard new loans. They can also help validate businesses, provide comprehensive risk scores that assess the viability of a business, aggregate and unify data from many sources, and leverage alternative data such as merchant commercial data.
One of the challenges for fintech lenders entering the small business market is that the ecosystem of prospects is less developed than in the consumer market. This means that small business-specific lenders have fewer tools and less robust databases than consumer lenders to find, select, and qualify loan applicants. Additionally, because small businesses are dynamic in terms of sales, debt, and other factors, data becomes stale very quickly.
The key to solving this problem is to work with a provider that can aggregate and integrate data from different sources to serve a variety of purposes.
At the start of the loan process, validation tools can help ensure that a small business’s information matches verified data collected from trusted sources such as the Secretary of State’s office, bankruptcy records, merchant cards, and the Office of Foreign Assets Control (OFAC).
Commercial risk scores leverage vast commercial credit databases that can predict the probability of success (or failure) with much greater accuracy. These scores consider trend data, public records, company characteristics and non-financial information. They can model multiple scenarios across a range of industries, helping to predict a range of outcomes, including delinquency.
Increased use of alternative data
Alternative data, such as merchant commercial data, is also an important tool for fintech lenders. This data can show lenders whether a small business is accepting payments or if there are issues with refunds or chargebacks that indicate a problem. For example, recent Equifax Data & Analytics Commercial Merchant Data found that small businesses with chargebacks exceeding 1% of revenue have nearly double the average default rate. It can also predict revenue declines: businesses that experience a 20% or greater decline in revenue over a six-month period, and where the decline is not due to seasonality, have a default rate 53% higher than average.
For true small businesses powered by one or a few employees, there is a large overlap between business and personal data. Using a provider that can aggregate both consumer and business data can help mitigate risk.
At the same time, alternative data can help lenders find high-performing companies, uncover high-growth prospects in near real time, and enable precise targeting and segmentation based on annual revenue and growth.
Human insight adds a meaningful dimension
As important as technology is, learning as much as possible about the business and its owners through human interaction is also important to making a sound decision. Armed with insights from data, lenders will need to use their judgement and experience to assess several key areas: Is the business plan sound? Why did you start the business? What are the owner's qualifications? Interestingly, one of the key points in the assessment is how well the business owner understands the relevant regulations. Those with more working knowledge have a much better chance of success.
As data and analytics providers expand their initial focus to small businesses, fintech lenders have a wealth of information at their fingertips. Small businesses continue to be an engine of the economy and an underserved group, meaning the potential for fintech lenders has never been greater. By learning about and leveraging evolving data and analytics tools, fintechs can continue to provide essential services to individuals, businesses, and the economy at large.