The pullback of banks from the small business lending space left a gap filled by alternative lenders who are exploring new ways to connect entrepreneurs with capital, a journey that includes innovation and a bit of experimentation.
With traditional lenders now turning their attention to the market newcomers, banks have the opportunity to embrace some of the innovations that have surfaced in small business lending – namely, banks’ adoption of online applications, faster decisions and capital disbursement times, as well as omnichannel advisory support for borrowers.
But SMB loan underwriting at traditional FIs has, for the most part, remained unchanged, even as alternative lenders began exploring the role of alternative data in the risk mitigation process. While traditional banks may rely on a business owner’s personal credit score to make a financing decision, FinTech is opening itself up to other data sources, such as utility bill payment habits and information found on social media platforms.
The issue at hand, however, is that Facebook stats are hardly reliable to traditional lenders mitigating the risk of small business borrowers.
“Lenders’ primary goal is to assess a consumer’s stability, ability and willingness to pay. Today, social media can’t address those needs,” said Experian in its first-ever The State of Alternative Credit Data report, published in May.
But some industry players agree that the traditional FICO score isn’t enough to correctly assess a small business borrower. An entrepreneur maxing out her personal credit cards to get a new business off the ground is not likely to impress a lender, for instance.
Michael Carter, CEO and president of BizEquity, has another vision in mind: lenders using the value of a small business to underwrite SMB loans.
“We think this is going to be part of the lending criteria going forward,” he told PYMNTS in a recent interview. “If you’re a small business owner and you go in for a loan, historically, the bank asks you two questions: What is your credit score, and what is your current income? They never ask what your business is worth.”
Convincing a bank to not only use a third party’s valuation of a small business in the underwriting process, but to also trust the accuracy of that valuation, is a tall order – but BizEquity may have taken a step closer. The company announced earlier this month that it is partnering with TD Bank in a collaboration, which links small business customers to a digital application through which they can see the value of their business (powered by BizEquity) and how it changes in real time.
So far, TD Bank isn’t using the tool to underwrite its own SMB loans, but Carter said the tool is still useful for small businesses – in more ways than one.
The first that comes to mind, of course, is when an entrepreneur is selling her business. In a 2015 survey by CNBC and the Financial Planning Association, 78 percent of entrepreneurs said they planned to sell their businesses to fund their retirements. Less than a third, however, had a succession plan.
At the time, Dr. Dave Yeske, CFP and managing director of Yeske Buie, told CNBC that “there is a huge perception gap among business owners of what it really takes to have a successful payday at the end of their career.”
According to Carter, part of that misperception might be attributed to entrepreneurs relying on business valuation services in the immediate lead-up to retirement.
“People value their business right before they sell it – that’s like planning for retirement the month before you retire,” he said, adding that entrepreneurs planning to use their businesses as a source of retirement funds must actively track and grow the value of their firms over time.
Decisions about hiring, firing and investing should also take into account the value of a business, and assessing how that value will change moving forward. Carter added that even insurance decisions should consider business valuations, and that a lack of visibility into the value of one’s business could result in the entrepreneur becoming under-insured.
But with BizEquity’s newest bank partnership, Carter said he particularly sees value in collaborating with third-party service providers like small business lenders, potentially forging a path for small business valuation to be used in the underwriting process. This goal would require data sharing agreements that could expand beyond the small business account and into other platforms, such as CRM and accounting systems, to more accurately assess business valuations.
That’s the “holy grail” for BizEquity, said Carter, who added that he believes the market is moving in this direction.
For now, however, he emphasized the importance of small businesses knowing their worth – and today, that may be less common than expected.
An IBISWorld report published in 2014 found that 98 percent of U.S. business owners don’t know the value of their companies. The 2 percent that do know tend to be larger enterprises. According to Carter, it’s not only expensive and time-consuming to deploy traditional valuation services, but the whole process is quite “intrusive,” particularly for a small business.
According to IBISWorld, demand for business valuation services is on the rise, particularly as a driver for mergers and acquisitions (M&A) activity, IPOs and retirement planning. Carter said that BizEquity focuses on artificial intelligence and machine learning to not only address the gap in small business valuation services, but also to introduce this process into the small business financial services space on a broader scale.
“We want to optimize the value of how to help business owners, advisors, accountants and bankers that serve them,” he said. “That’s where AI is so powerful.”