Since 2021, U.S. entrepreneurs have submitted five million new business applications per year, according to the U.S. Census Bureau. And in 2023, the number of new small business formations increased by nearly 9% compared to the previous year, suggesting that the growth of the small business sector shows no signs of abating. This creates a massive opportunity for fintech lenders.
When seeking a loan, small businesses will often look first to their depository bank. That’s natural when you consider that a relationship of trust is already in place.
Further, the depository bank has a lot of data on the small business. This allows the bank to conduct outbound marketing – a banker may anticipate a small business’ need for credit even before the owner does – and can create a smoother process as the loan moves through the system.
Fintechs, however, have an opportunity to approach small businesses from a different angle. The best way to do this is by offering a superior lending experience, which could include a simpler application process, faster decisioning and funding, and a more flexible credit box that enables the approval of candidates that were declined by their depository bank.
From equipment loans to working capital credit lines, the opportunities are substantial in the small business market, but fintech lenders must have safeguards in place and do their due diligence using the most up-to-date technology and methods. As of February 2024, small business default rates have increased for 18 months straight, according to Equifax Commercial trends data. Lenders need the best available information to pursue a high volume of loans that also fit within their risk parameters.
Tech tools evolving quickly
Providing an improved customer experience while managing risk requires embracing technology. Luckily, fintech lenders have a greater array of data and analytics resources available to them than ever before. These tools can help better identify quality leads and securely vet and onboard new loans. They can also assist with business verification; provide comprehensive risk scores that assess business viability; and aggregate and consolidate data from many sources, as well as leverage alternative data such as merchant commercial data.
One challenge for fintech lenders in reaching the small business market is that the prospecting ecosystem is not as developed as the consumer market. That means small business-focused lenders have fewer tools and less robust databases at their disposal than consumer lenders as they work to find, select, and screen loan applicants. Further, small businesses are dynamic in terms of sales, debt and other factors so data becomes stale very quickly.
The key to solving this problem comes from working with a provider that can aggregate and consolidate data from a variety of sources to serve a variety of purposes.
At the beginning of the lending process, verification tools can help confirm that a small business’ information matches verified data collected from trusted sources, including secretary of state offices, bankruptcy records, merchant cards and the Office of Foreign Assets Control (OFAC).
Commercial risk scores can draw on vast commercial credit databases that are able to predict the probability of success (or failure) much more accurately. These scores take into account trended data, public records, and firmographic and non-financial information. They can model multiple scenarios across a range of industries, which can help predict a range of outcomes, including delinquencies.
Growing use of alternative data
Alternative data, such as merchant commercial data, is another critical tool for fintech lenders. Among other things, this data can show lenders if a small business has been accepting payments or has any refund or chargeback issues that indicate a problem. For example, small businesses that have sustained chargebacks greater than 1% of sales, have nearly double the average default rate, according to recent Equifax Data & Analytics Commercial Merchant Data. Sales declines can also be predictive. Businesses where sales decrease over 20% in six months –and the decline is not due to seasonality – have default rates 53% higher than average.
When looking at a true small business with one or a few people as the driving force, there is significant overlap between business and personal data. Using a provider that can aggregate both consumer and business data can help reduce risk.
At the same time, alternative data can help lenders find businesses that are doing well, uncovering fast-growing prospects in near-real time, and enabling precise targeting and segmenting based on annual revenue and growth.
Human insights add meaningful dimension
As important as technology is, making sound decisions is also a function of learning as much as possible about the business and its owner via human interaction. Lenders must use their judgment and experience to assess a number of critical areas as they build on insights gleaned from the data. Is the business plan solid? What was the rationale for starting the business? What are the owner’s qualifications? Interestingly, one key point for evaluation is how well the business owner understands relevant regulations. Those with a strong working knowledge have a much greater chance of success.
As data and analytics providers have expanded their initial focus to encompass small businesses, fintech lenders have a world of information at their fingertips. Small businesses continue to be an economic engine for the economy–and a significantly underserved group–meaning that the potential for fintech lenders is greater than ever. By learning about and harnessing evolving data and analytics tools, fintechs can continue to provide an essential service to individuals, businesses, and the larger economy.
