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Stepping into the Small Business Lending Void

Adam Rust's picture

Posted October 11, 2012

If your bank won't make a loan, then who will? There are a lot of myths about small business lending: some say it is the last place where community banks have a competitive advantage, some say that it begins and ends with SBA, and others assume that all small business loans are without their problems.

The truth is that small banks are increasingly ceding small business lending to big banks. SBA does account for

plenty of loans, but it is fraught with complications that make it attractive. Finally, there are all kinds of small business loans and some are not so great. The Department of Commerce calls it a loan when a small business gets its own credit card.

I think that those banks - especially the small banks that should have the capacity to know their customers - could get more loan volume if they used more imagination. Some businesses, particularly newer ones, are never going to look that promising under traditional ratio analysis. Can someone provide an alternative model when a borrower has a damaged credit score, the wrong revenue patterns, a lack of collateral, or a limited business history?

I covered this from a macro perspective yesterday. One approach that works for small and medium sized retail businesses. It is a model that can aid traditional brick-and-mortar retail as well as the new breed of online firms.

Capital Access Network ("CAN") began when one of its founders could not get a loan for her Gymboree franchise, in spite of the fact that she could show evidence that she had a successful business.

CAN offers working capital via its two subsidiaries -  AdvanceMe and NewLogic. AdvanceMe collects by taking a share of a company's credit and debit swipes until the outstanding obligation is satisfied. There is no calculable rate of interest, given that the term extends or shrinks according to the pace of revenues. CAN's money still has a cost. In one example offered to me by the company, a borrower received $25,000 capital with a future swipe obligation of $27,000.

When a company is doing well, AdvanceMe collects quickly. When they aren't, AdvanceMe is patient. For businesses with a seasonal revenue mix, this kind of collection system softens debt service during down periods.

New Logic Business Loans differs in that it takes fixed payments for a fixed term, but it serves the same customer group and it collects on a daily basis. Whereas an AdvanceMe borrower might make $40 in payments on Tuesday but $82 on Thursday, a borrower pays the same sum on a NewLogic loan at the end of every business day.

The benefit here is not just in terms of who can access a loan, but also the speed. While an SBA 7 (a) loan can offer mid-length loan terms with reasonable costs, applications can take several months to process. An MCA through AdvanceMe or a NewLogic loan can be approved in seconds and the cash can be in the hands of a borrower in less than forty-eight hours.

I am not sure how someone can turn around with an answer that quickly, but I suspect that it involves some mad math. Any bank with any exposure to trading (large and regional banks) should be able to put those resources to small business lending, but few do. If CAN has about 80 people working in data systems, it might be 79 more than your typical small community bank.

Their best "vertical" is among those borrowers seeking money for businesses in medicine: doctors, vets, dentists, among others. There is also an opportunity for this kind of lending with online businesses, which are more suspect to a traditional bank given that they have no physical presence. Earlier I wrote about Kabbage, a lender that underwrites E-Bay stores based on feedback scores.

"As difficult as it is to get capital these days," says CAN CEO Glenn Goldman, "you can still invite the banker to come by to the store. Imagine how much more difficult that is when you can only invite the banker to your home page...."

The mechanics of underwriting at CAN:

  • Less emphasis on credit scoring: “Some of our best customers have FICOs of 400 and we turn down people with 800 all day.”
  • Examine the interaction among a cluster of variables: "When two or three or four behaviors or variables exist at the same time, is there some correlations between that and either good performance or bad performance? For example, declining seller ratings with certain types of upward trending sales trajectories coupled are [sometimes] indicative of a business that is going well but having a difficult time fulfilling and thus has a specific need for capital." See online retailer theLatinProducts.com.
  • In business and operating from the same location for at least a year. The borrower should be current on rent.
  • The challenge for a non-bank may be less about the risk of underwriting but instead about marketing. Borrowers are sort of like lenders - they trust a branch more than they do a web page. Identify potential borrowers through relationships with intermediaries: leasing brokers sometimes introduce potential tenants to CAN. As well, CAN's logo and contact info are displayed on the direct mailings that banks sometimes send to their business account holders.

I think people are waiting to see how new firms enter this gap. Usually the best time to enter a market is when it is struggling. I have heard that even the demand for the albatross of the last decade - the subprime MBS - is suddenly returning 30 percent to those that dare buy.  Accel Partners recently made a $30 million investment in CAN.

CAN is just one example that should force people to re-examine how the small bank-small business-small mindset serves its customers. The larger problem remains that it can be hard for many small firms. It can be even harder to get a patient loan.