In small business lending, the rush of alternative players entering the market is beginning to give way to consolidation — or, at least, collaboration. Lately, companies have been discussing the role of banks in this pairing-up of old and new; financial institutions provide their capital and consumer base, while alternative FinTech players provide the innovative technology and the underlying infrastructure to connect small businesses with loans.
But there are other types of pairings as the alternative SME finance industry continues to find its footing.
“A lot of thinking going on within the traditional financial institutions is on what’s next and where should they go. Should they build capacity themselves? Should they partner with third parties?” asked Troy Wright, founder and CEO of Canadian alt-lender Lendified.
Lendified announced last week the acquisition of Mentio, a cash flow forecasting company using data from cloud-based financial systems to analyze and predict the future performance of a business.
Such technology is a natural fit for any lender, traditional or otherwise.
It also signals a different kind of consolidation in the alternative finance sector, with different FinTech companies joining up to enhance the sophistication of technology behind lending and credit underwriting.
Wright, along with Lendified President Kevin Clark and Mentio CEO Monique Morden, spoke with PYMNTS about the link between SME cash flow forecasting and the ability to reduce risk when financing these companies.
The Cash Flow Forecasting Legacy
Cash flow forecasting has traditionally relied upon data sets that don’t always provide the whole picture of financial health for a company, the executives said.
According to Morden, cash flow forecasting is key for any company, and regular forecasting practices can lead to a thriving business. That doesn’t mean everyone does it, though.
“A lot of organizations don’t do it because it’s complex, it’s repetitive and they’re busy,” she explained, adding that smaller companies are especially at a disadvantage in terms of time and resources to invest into a cash flow forecasting service.
The continuing reliance on manual accounting and cash management tools, said Morden, adds to the difficulty in terms of accessing the data required to accurately forecast a company’s future performance. Adoption of cloud technologies is on the rise, and that’s good news for both the cash flow forecasting and credit underwriting businesses, Morden said.
“If you’re not using cloud accounting software, it’s really difficult to figure out what your cash flow is going to be,” she explained. “There are all sorts of organizations where it can still be difficult to determine what their cash flow is. But the accessibility of cloud accounting software — and software for small businesses in general — is going to help them catch up.”
The SME Underwriting Legacy
The outdated methods of assessing a company’s future performance are the very same tactics used to assess a company’s past when underwriting a loan.
“Lending to a small business has had a high reliance on your personal credit score, which doesn’t really give the business an opportunity to stand on its own two feet as a company; it’s just looking at you as a person,” said Wright. “It’s often a big problem in terms of small businesses accessing loans.”
The executive added that existing available data sets, like FICO-type credit scores or Dun & Bradstreet reports, are at least a bit more reliable — but still not adequate.
“They’re not necessarily very good, because they’re quite stuck in old ways of thinking,” Wright said.
Banks and traditional financial institutions are perhaps most susceptible to this barrier to an alternative of risk mitigation.
“The traditional way of going into a bank to seek support really gets delayed, because the small business credit officer at a bank doesn’t have the tools and mindset to be thinking that way,” stated Clark. “They fall back on traditional, historical analysis, which can be dated or not accurate.”
“This frustrates the borrower, and this frustrates the lender,” he added.
The acquisition of Mentio, said Wright, is about broadening the scope of data that funnels into Lendified’s underwriting process.
“What Mentio does is give us access to accounting information, which provides a historical view of how the company is doing but also, as a forward-looking cash flow projection, to be able to understand what’s coming ahead and what the payment and financing capacity is in the business,” he explained.
Good Data, Bad Data
In the era of the cloud and Big Data, companies are beginning to figure out how to sort good data from bad data. The marriage between Lendified and Mentio, the executives said, is part of that progress.
The acquisition, explained Clark, pushes Lendified “down the path much faster” of improving the technology behind credit underwriting than what would have been accomplished with the internal development of such data analytics capabilities.
But broadening the scope of access to financial data doesn’t necessarily mean the credit underwriting process will become flawless.
Wright said the direction of the small business lending industry is about more sophisticated analytics capabilities to mitigate risk. But that can only happen, he added, through trial and error.
“What I think is going to be the future is all of these different data sources are going to significantly improve the ability to measure risk,” he explained. “How? By testing and learning.”
Machine learning and the addition of new variables into the analytics process can help weed out the good data from the bad, he added, suggesting that, as this evolution continues, small business lending is likely to even eliminate the personal credit score altogether.
Morden made sure to highlight the uphill battle the industry has when it comes to a better underwriting process. It’s a difficult process and one that Lendified is looking to tackle through its acquisition of Mentio.
“If you get all of this data, you really need to have the expertise and the analytics to be able to determine what’s important and what’s not in putting the risk and credit models together,” the executive stated. “And it’s not for the faint of heart.”