Ditching FICO, And Finding Another Path To SME Loans

The struggle of small business borrowing is well documented. Indeed, it’s the underlying reason why the alternative SME lending industry exists. But even alt-lenders have their limitations when trying to link small businesses to financing.

Part of the problem, explains Eyal Shinar, founder and CEO of small business invoice financing platform Fundbox, is that too often lenders are forced to fall back on profiling the small business owner — not the small business itself — to underwrite a loan.

Fundox launched to circumvent this issue by linking itself direct into accounting and ERP systems, able to assess financial data of a small business to gain an accurate picture of a company’s cash flow and financing the outstanding invoices necessary. But that strategy doesn’t cover all businesses: Many small firms aren’t using the accounting and ERP systems Fundbox uses in its underwriting process.

“We got a lot of feedback from our customers that don’t use accounting software,” Shinar recently told PYMNTS. “Many small businesses are using Excel spreadsheets and paper, and we want to address those customers as well because they have the same cash flow problems.”

The executive said it took a long time, but today Fundbox announced Direct Draw, a way to include more small businesses into its invoice finance offering. Using artificial intelligence, Direct Draw links to SMEs’ bank accounts, the data from which is used to analyze financial history and behavior. That information, along with data from other sources, gets aggregated into Fundbox’s Small Business Graph, which, Shinar explained, not only takes into account a small business’ operations, but examines its customers, suppliers and other business partners as part of a broader profile.

It’s an expansion of Fundbox’s existing offering, the CEO said, all of which shies away from depending on personal credit histories to finance a small business.

“We keep a few principles,” he explained. “First, it is very fast and a clean user experience. Second, you’re not required to provide any FICO score.”

FICO is deeply rooted in small business lending among both traditional and alternative financiers, Shinar noted. They aren’t necessarily misguided by that tactic either.

“There are good reasons why FICO is used,” he said. “It’s been a powerful tool to predict credit strength, though it’s focused on consumer credit.”

FICO has recognized its role in small business finance. Earlier this year, the company announced the launch of Origination Manager Essentials, a tool for banks and credit unions to use FICO’s Small Business Scoring Service and other data analytics capabilities to underwrite a small business loan.

But according to Shinar, this isn’t typical of how FICO is used by small business lenders for underwriting purposes. Many small business owners are forced to rely on personal finance to get their companies off the ground. For instance, they may take out a credit card or a personal loan, blurring the line between personal and company finances. When lenders look at a potential small business borrower, they tend to look at who’s behind the business: the owner. FICO is almost always a part of that process, said Shinar. But there are shortcomings to the strategy.

“When you start a business, you deploy capital and maximize all of your available credit lines, whether with personal credit cards, or a personal loan, or a business loan tied to personal credit history,” he explained. Someone maxing out these credit lines to build a successful small business over the span of a few years is likely to have taken a hit or two on their FICO score, even if the company is thriving.

“If I have a successful business and spent the last five years building it with my own blood, sweat and tears — and my personal FICO score — then my score will be low,” he said. “I may have a good business, but the banks will use the FICO score, which doesn’t reflect the health of the business.”

Entrepreneurs have caught onto this issue, too. According to Fundbox, the majority of small business borrowers don’t think the FICO score should be tied to the underwriting process at all, something Shinar said doesn’t surprise him.

“In most cases, personal credit has nothing to do with the business,” he said. But, he added, banks and other lenders have to fall back on FICO when they can’t allocate the resources to truly assess an individual SME. Technology, and artificial intelligence in particular, are critical to overcoming that challenge for both lenders and their small business borrowers, Shinar said.

Fundbox estimates that 18 million small businesses remain underserved by lenders because they require personal credit histories to finance a small company. Separating business from personal finance may not only prove to be a more accurate way to underwrite a small business loan, Shinar noted, but can improve the finances of small businesses and their owners alike.