The notion that new commercial financing companies are going to ‘fill a hole in the market’ for SMBs to gain access to capital is a constant but I don’t think it's accurate any longer. I see this repeatedly in press releases for a new entrant to the business lending market. The need for capital by small businesses is certainly there but most new lenders are not inventing a new product or disrupting a segment in any way. They may improve on products in some way however there is established competition at every turn. There are a wide variety of lending options available. So is there really still a large gap in the market of financing options for small to medium-sized companies or is it the lack of knowledge by business owners and entrepreneurs?
I would argue the latter given studies that have come out and my experience with business owners directly and industry professionals.
It's important to distinguish between the variety of financing options from the volume of lenders. For certain products, there is room for more lenders to offer them. For others, there are too many to count which is a positive thing for merchants.
Pathward study
According to a survey by Pathward (1,000 Nationally Representative US
Small Business Owners with 10-200 employees), 60% of business owners can explain to another person what an SBA loan is, and 57% what a Business Line of Credit is. The percentages to explain the other loan products drop substantially after that.
My interpretation of this:
SBA loans at the top should be no surprise given the history of the federal government backing it, business owners have traditional banking relationships so they are usually made aware of it, and SBA loans have the lowest rates if you can qualify.
A Business Line of Credit is not too unlike a personal one so it's not complicated.
But besides the term loans, other business financing options are a bit more specific, newer to the market, or aren’t an obvious solution to the problem.
Less than 40% of business owners in general know what equity financing is or what asset-based loans are enough to explain to someone else. That's very telling for the opportunities that are there if business owners become more educated.
I don’t have a similar study from 20 years ago but I think we can all agree these percentages were much less and the options were far fewer.
Educating business owners
This is where the education comes in. Of those on the front lines in the lending process are business loan brokers. They are more aware of the business loan options which should then be passed on to the business owner. If the business loan broker is doing their job well, they educate the business owner and help solve their financing problem. The same can be said for anyone else communicating directly with business owners. This creates the broadening of awareness of all of the financing options that are alternative to traditional bank loans.
The right fit
Brokers should be able to take a file and find a suitable loan option for it but if they don’t it's not that there is a hole in the market. It just may be that the client doesn’t currently pass underwriting for any lending option. There are countless individual situations where a company won’t qualify because of factors including credit, revenue, time in business, or industry.
Does that mean someone could invent or adjust a product for that client, sure, but at what risk and cost of capital?
To fill a niche space is still possible however now it's more about improving by technology, innovative underwriting, and reducing friction in the loan application process.
Newest segment
Embedded lending is the newest lending segment in the market. It is an example of a breakthrough in business lending. The embedded lending options have increased because the technology has improved so much and it has become the go-to option for many business owners. Some business owners might only stumble upon an embedded lending option as they are using their Quickbooks or Stripe payment processing account, but once they do it's one of the most frictionless ways of obtaining working capital.
The cost of capital may be slightly higher than other options but the advantages of the service make up for that difference. Embedded lending has a low default rate that's very attractive to providers. Traditional banks are partnering with embedded lending providers and alternative lending companies are doing the same.
Marketplace providers or other middlemen are creating their own embedded lending platforms for others to use, for example, Lendio and Rapid Finance. When a business owner goes through Lendio directly or through a partner, there aren't many deals that don't have a potential home for their financing given the over 75 lenders that they have access to. When someone does not qualify, again, it doesn’t mean there is a hole in the market or that a new product needs to be invented. It may just mean that the business owner has lots of work to do before they can qualify for any financing.
Going forward
Knowing lending options isn’t inherit as a business owner, they have to seek it. It can be a daunting task for many small business owners to find out what options are available and to narrow it down to the best one for their situation. With so much information (and misinformation) online it’s our duty as industry members to educate entrepreneurs in any way possible by spreading awareness of the various loan products. While new entrants to the business lending market are providing a need, they aren’t filling a gaping hole. The hole is in education on the various lending products.
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