It is no secret (small and medium-sized enterprises) SME’s, supposedly the backbone of the American economy and the creator of most new jobs, are still having a hard time securing credit from traditional sources.
That does not mean SME’s are not getting credit at all, it means more and more of them are getting it from non-traditional sources like AmeriMerchant, a financial tech company which uses proprietary technology to provide different forms of working capital to small businesses.
I contacted AmeriMerchant Founder and CEO David Goldin to discuss Staples’ new business loan service. That provided a starting point for an interesting discussion which touched on many different areas of alternative finance.
In many ways Staples is a natural platform for providing small business loans. Much of their customer base are small businesses, and many more order their office products online.
There are also many cross-promotional advantages an established service provider who cuts across all business has when expanding to an industry with many potential clients who do not know they exist. A small business owner goes to Staples’ website and sees a credit opportunity they did not know existed. There are some nice links there.
“Staples is viewing it no differently than any third-party product they are getting a revenue source from,” Mr. Goldin said.
“If you look at Staples online, and others, they offer third-party products, whether it’s payroll services, business credit cards, or business loans. Web design companies host content. It is part of a natural extension where they are essentially an affiliate for Lendio.”
Opportunities like the one Staples is capitalizing on exist for two reasons, Mr. Goldin says: Credit and structural.
It costs the same amount for banks to underwrite a $30,000 – $40,000 loan, which is the average ask for an American small business, and a $100,000, loan, which is the ante for most banks, so if they deal with smaller players at all, it is as quickly as possible.
“A bank cannot make money underwriting a $20,000 or $30,000 loan,” Mr. Goldin said. “So what happens is banks tend to use certain products that are ‘yes’ or ‘no’ like business credit card, which not all businesses will qualify for, or a home equity line. Not everyone wants to pledge their house, do not have any equity in their house, or they rent.”
Then there’s the little issue of collateral.
“Banks also require hard assets they are lending against,” Mr. Goldin explained. “Take a restaurant in New York City. You’re not going to own that building, so what are the assets? The menus, the liquor and table cloths.”
A shift in marketplace philosophy has created opportunities alternative lenders are capitalizing on, Mr. Goldin said. In the recent past there were deals-a-waiting but not enough cash, now it is the opposite.
“I think what you’re seeing in the marketplace today is all the hedge funds and funds and pensions are trying to get yield. Now there is plenty of institutionalized capital and not enough deal flow. So you’re seeing plenty of companies emerging as an alternative to banks. That really opens the floodgates to small business’ access to capital.”
Filling that void isn’t as easy as watching a Go Daddy Super Bowl ad then calling up and getting a website built. Companies like AmeriMerchant combine standard data types with analytical capabilities which undergo constant refining.
“We have 13 years of data and we’ve built a proprietary underwriting and scoring algorithm that can actually make decisions now within 60 seconds,” Mr. Goldin said.
For the algorithms to do their job, you need plenty of data, but you need to make sure it’s the right data. Where platforms find their edge is in looking at non-traditional types of data that prove to be accurate indicators of risk.
“We do not just look at business credit score,” Mr. Goldin said. “There’s a lot more than the FICO score. We look at cash flow trends and understand many businesses don’t have a lot of assets to pledge.”
“Some don’t have strong credit scores and we’re still able to lend to them and provide access to capital. We also have a very low default rate.”
Those who follow alternative finance can be forgiven for thinking it is booming, but a look at the numbers with David Goldin shows the actual boom, in hindsight, isn’t even on the horizon yet.
“All this alternative lending is about three percent. The biggest one probably does $700 million to a $ 1 billion dollars a year. An average loan size of $40,000 to $50,000 means they are doing about 1,000 loans a month. Half their customers are new so that means they are only funding 500 new customers every month. That’s nothing. That’s 10 per state.”
“We haven’t even scratched the surface, we haven’t scratched the scratch of the surface, we aren’t even anywhere near the surface.”
“I don’t think any of us have the money to compete with Bank of America, Chase or Citi,” Mr. Goldin admitted. “But I think over time, esepcially since Lending Club and OnDeck went public you cannot turn on the news without hearing about these alternative lending platforms.”
“Over time the entire (alternative finance) industry will be more and more accepted. If I asked you five years ago how many people would order a taxi through their iPhone or a car service you’d probably have said, ‘oh it will take time.'”
“Disruption’s definitely coming, there is no doubt about it.”
Data analysis also involves what initially looks like a bit of odds playing, with some “if this, then this” scenarios being played out. Such data needs to be looked at in its entirety, Mr. Goldin advises.
“(Platforms) use years of data from the marketplace from which they can spot trends. For example a business owner has a website. Do they tend to perform better? Yes or no?”
“Does a business owner happen to do this? Are they in a certain location? If they have been in business for a certain number of years, do they tend to do better?”
The old data still plays an important role.
“Let’s also not kid ourselves,” Mr. Goldin admitted. “Experion and Equifax didn’t become billion-dollar companies by luck. A FICO score is still pretty powerful.”
And 2015 will provide some significant storylines, whether they are judged by hype or actual impact.
In terms of alternative finance, the initial rate hike will be much ado about nothing, Mr. Goldin said.
“Rate hikes won’t affect the industry.”
More interesting is alt-fi’s growing accepting in increasingly wide financial circles.
“Traditional institutions are starting to face the fact alternative lending institutions are not a fad,” Mr. Goldin observed. “They’re not going away.”
“Smaller community banks are looking to buy loans off smaller platforms. They don’t want to invest the capital to underwrite the loans themselves so they will send their customer to a platform like ours and potentially buy a loan off our platform.”
Mr. Goldin also expects the bigger players to begin snapping up profitable niche players in the coming years.
Goldin is also a founding member and President of the North American Merchant Advance Association (NAMAA), a 501c trade association representing the merchant advance industry.
“NAMAA establishes best practices for the alternative lending industry,” Mr. Goldin explained. “We encourage members to disclose fees to customers and to engage in responsible lending. We also help members to make sure they are not defrauded by merchants.”
NAMAA also plays an important educational role so people comparing merchant advance loans to other forms of credit are making accurate comparisons.
“When people argue money’s expensive they don’t look at the whole picture. There may be no personal guarantees, no recourse, and banks may have to pay attorney fees of $10,000 to $15,000 for an agreement.”
“We try and point things out so its apples to apples for customers.”
One final factor for capital-seeking small businesses to keep in mind is time, David Goldin said.
“You may wait six weeks for a $20,000 loan when you could just sell receipts within an hour. Remember time is money too, it’s not just about the cost. In the time it takes to grow your SBA loan you may be able to grow your business faster.”
“We can actually plug into Staples’ customer base right away and using our API we can give real time decisions to their customer as to how much of a loan they’ll qualify for.”