By Adam Hoeksema
The financial services industry is ripe for disruption on a number of fronts. In my opinion, small business lending is one of the most likely sectors to see a complete transformation. I have listed 5 predictions that I believe will impact small business lending by 2020.
1. Personal Credit Scores Will Have LITTLE to do With Small Business Loan Approval – Currently, lenders look at the personal credit score of the business owner as a major factor in the creditworthiness of the business. Clearly, the personal credit score has no bearing on the quality of your business model, marketing plan, or profit margins. In the past, banks have had no other option because other (more relevant) data was not readily available.
New data is becoming available. For instance, Intuit can provide data to banks including:
- Accounting Data through Quickbooks
- Industry Data through Quickbooks
- Personal Budget and Financial Data through Mint.com
- Personal and Business Tax Data through TurboTax
If a bank can access this data for individual borrowers and compare to the aggregate numbers provided by Intuit, the personal credit score starts to become the least relevant piece of data.
2. Peer to Peer Lending and Crowdfunding will Dominate the Traditional Bank – Major platforms like Prosper.com, LendingClub.com, and Kickstarter have such an incredible advantage over traditional banks when it comes to small business lending. A bank may not even be able to make a profit on a loan that is $50,000 or less because of the incredible overhead costs. Web-based platforms don’t need a physical branch location in every city to get distribution of their loan products. Without that overhead these online lenders will be able to start lending profitably at a much lower dollar amount. Right now a borrower might only be able to borrow up to $30,000 on these platforms, but by 2020 I am certain these lenders will find a way to increase their loan capacity in order to eat away market share from the traditional bank.
Online lending is simply more efficient, it is only a matter of time before online lenders will do to the banks what Amazon.com is doing to retailers.
3. Cash Flow Will Still be King – On Deck Capital is already proving this to be true. On Deck looks for businesses with a large number of smaller clients. For example, a grocery store has a large, diverse customer base that is consistent. On Deck can look at their credit card deposit data and feel very comfortable lending based on the fact that they are generating cash, and it is protected from a major shortfall because of the diverse customer base.
4. Factoring Receivables Will Become Incredibly Efficient For the Small Business – New web based technologies and data will make it much easier to factor smaller invoices. The Receivables Exchange is already proving that it is possible to factor receivables much more efficiently. In the past a business owner might give up 10% of their sale for cash today instead of waiting 45 days to get paid. If you annualize this interest rate, you will see that it is a terrible way to finance a business. The Receivables Exchange is ultimately much cheaper because it diversifies risk for everyone. I might purchase a small portion of your invoice along with 100 other people. You end up paying a small percentage of the invoice in exchange for getting your cash up front.
Right now, the invoices must be bundled in $10,000 increments at minimum, but I believe this type of system will ultimately allow you to sell very small invoices which will reduce your need for a line of credit from the bank.
5. Two Years in Business Won’t Matter Anymore – Business moves fast these days, and it is only going to accelerate. In 2 years Groupon went from nothing to hundreds of millions in sales. In less than 2 years Instagram was launched and purchased for $1 Billion. Not every business will move that fast in 2020, but I believe that banks will have the data and technology needed to analyze the creditworthiness of a loan applicant without considering whether or not they have been in business for 2 years.
If the business is growing, and can afford the loan, 2 years of operating history should not be required.
I am sure I am wrong on some of these points, but in my opinion the next 5 to 10 years is going to be a painful one for the traditional small business lender. Small businesses will find other sources of funding that are becoming available at an accelerating pace. I think most business owners are incredibly frustrated with their current bank, and would leave them in a minute if there was a better alternative. Once they leave, it will be nearly impossible to get them back.
I would love to hear your thoughts on the subject. What predictions do you have?