Use of alternative finance (AltFin) sources among small business (SMB) owners is on the rise, but still has a long way to go before it poses a legitimate threat to traditional banks' market dominance.
Mercator Advisory Group data released earlier this year found that 27 percent of small businesses in the U.S. have already used an alternative lending platform, particularly among younger entrepreneurs. Yet, analysts found only a slight change in alternative finance use between 2016 and 2017, and nearly half of SMBs have still never turned to AltFin for financing.
The obvious explanation is that FinTech financing platforms are still too new to the market for small business owners to have even heard of them. However, there are other reasons why entrepreneurs don't explore all their options, whether it be the variety of loan products available from a traditional lender or the variety of alternative lenders that may be able to fulfill their financing needs.
"Sixty percent of SMBs spend less than an hour shopping around for finance," explained Ciarán Burke, co-founder and COO of Swoop, a U.K. firm that bridges companies with a range sources to obtain loans, equity financing or grants. "It can be a hugely time-consuming exercise researching all the traditional and alternative financing solutions on the market."
In addition to the time and manual effort needed to shop around, Burke noted that the biggest barrier is SMBs' lack of understanding with regards to what makes them eligible for financing products. A lack of understanding of one's debt service ratio score, and how applying for debt facilities might impact their credit rating, not only means an inefficient search for financing, but could lead to financial harm for a business.
Swoop's solution to this dilemma is to work directly with small business advisors and accountants — professionals who have the financial experience and education to assess what solutions would be the best fit for their clients. The company takes a collaborative approach with its newly launched funding platform, integrating with a small business' accounting platform via application program interface (API) to short-list the financing options for which the business qualifies. The accountant is then able to choose the best option for the company, and continues as the point of contact for funding providers.
Key to this solution is the U.K.'s recently enacted Open Banking legislation, allowing Swoop to obtain the financial data that must be analyzed to assess the best financing options.
"The access to these richer and more accurate data sources allows for better lending decisions, faster capital and more innovative solutions, which puts the SMB and lender in a much stronger position," noted Burke. He added that this access to data from bank accounts and accounting platforms not only accelerates the underwriting process, but reduces risk by preventing financiers from relying on outdated data to make their decisions.
Open Banking can indeed streamline the process through which small businesses explore a variety of financing products from many sources, both traditional and non-traditional. Yet, Burke said one of the biggest market shifts he's anticipating for the year ahead is how traditional financial institutions (FIs) adjust their position in a market that continues to add new alternative lenders and challenger banks.
Even when a micro-loan to a small business won't benefit a traditional bank's portfolio, Burke said it's still valuable for traditional FIs to know when a small business has begun its financing search. Swoop is beginning to white-label its platform for traditional banks to link their SMBs to alternative financing when they aren't suited for a bank loan, allowing business owners to get financed while still staying connected to their banks.
In addition to the Open Banking policy, U.K. policymakers have taken measures to promote use of alternative finance as small businesses struggle to obtain traditional bank loans. The biggest example of this effort is the bank referral scheme, a policy that requires banks to refer SMB clients to alternative financiers should they be rejected for a loan.
So far, the effect has been muted. Data released by the government in September revealed that only $20 million in SMB funding has resulted from the scheme in the nearly two years since the policy began. Fewer than 1,000 small businesses were referred to an alternative lender by their banks between November 2016 and August 2018.
At the time, experts warned that while the referral scheme is, in principle, a good idea, it is still imperative that small businesses understand what they're getting from an alternative lender, and read the "fine print."
According to Burke, Open Banking can support connectivity between traditional lenders, small business clients, their accountants and potential alternative lenders to broaden SMBs' access to financing, while still supporting a stronger understanding of what products are best-suited to each business.
"We predict that banks will start to build out relationships with panels of lenders that suit early stage businesses at various levels of funding, up until the point where the bank wants to start coming into the market," noted Burke. Not only will this help to broaden awareness of alternative finance, but it will enable businesses' to understand "that it is normal to use various forms of funding and move across providers as their business changes."