For many small- and medium-sized businesses (SMBs), the Covid-19 pandemic and recent economic shocks magnify some of the usual vulnerabilities and risks in servicing this segment. We examine the risks and opportunities SMBs' current financial troubles present to the fintech ecosystem.
During economic downturns, small- and medium-sized businesses (SMBs) are typically hit the hardest.
Unlike larger, more established firms, they have small cash buffers and depend on external capital to sustain growth. The median US-based SMB has 27 days of cash reserves on hand, meaning that it can only pay its expenses — with no cash inflows — for less than a month.
Small businesses accounted for 60% of total job losses during the last recession. Such low cash buffers help explain why small businesses rely heavily on external financing in times of crisis.
Below, we dig into how the financial difficulties that many SMBs face could impact fintech companies (especially B2B fintech startups).
What a cash flow crisis means for fintech companies
1. ALTernative LENDERS FACE A PIVOTAL MOMENT
SMBs need financing, but many banks have been slow to process loan applications and even slower to disburse funds.
Aid-related or not, alternative (non-bank) lenders have an opportunity to step in and demonstrate technological advantage over incumbent lenders through faster loan processing and payment.
Alternative lenders are able to participate in the government’s CARES Act loan program, which provides loans to SMBs on a first-come, first-serve basis. Fintech companies Ondeck, PayPal, and Intuit have received approval to participate as direct lenders.
The government has backstopped these loans so that lenders can take on minimal credit risk; however, alt lenders carry existing credit risk from non-government-backed SMB loans — and the longer the economy remains on pause, the higher the likelihood these alternative lenders will suffer increased losses resulting from existing borrower defaults. As a reference, 10-year default rates for SBA loans provided by traditional lenders have ranged from 12% to as high as 25%.
Most alternative lenders, such as BlueVine, and the algorithms their lending decisions rely on are a post-2008 phenomenon. As a result, many fintech lenders will see their lending algorithms stress-tested for the first time.
2. LENDING MARKETPLACES CAN SHOWcase THEIR UTILITY
Lending marketplaces can also participate in disbursing SBA funds by matching lenders to borrowers.
Lendio, for example, has facilitated more than than $5.5B worth of loan applications. Biz2Credit and Fundera are 2 other lending marketplaces that have encouraged businesses to apply for SBA funds through their websites.
Lending marketplaces can cement themselves as go-to sources for SMBs and their financing needs. This means maintaining an adequate pool of lenders able to service the surge in loan demand that some platforms may experience. Financially, these lending marketplaces may fare better in this environment, as they do not directly lend and, therefore, do not take on balance sheet risk.
3. ONLINE PAYMENT PROCESSORS CAN BENEFIT
Covid-19 may be a tailwind for online payment processors, as businesses that have traditionally earned revenues in-store may look to set up an online presence to capture some of those lost in-store sales. Payment processors such as Stripe and Square could benefit from SMBs rushing to set up online payments. Notably, both companies have set up Covid-19 resource centers for businesses.
Pandemic or not, the move to online payments is already occurring. The accelerated focus during this time is an opportunity for online processors to strengthen the relationship they have with existing customers, as well as earn the trust of new customers that are looking to regain lost in-store revenues.
4. FINTECH COS HAVE A CASE TO MAKE for government adoption
The pandemic has highlighted the critical need for the government to embrace financial technology. The delay-riddled SBA loan program shows how the US’ back-end financial infrastructure, especially between banks and governments, could benefit from fintech innovation. For example, E-Tran, the government portal that manages the SBA loan program, recently suffered from prolonged outages and extensive delays caused by overwhelming demand.
The delays in getting loans processed and disbursed could put SMBs in critical condition, given their typically low cash buffers. One example of how fintech companies in other countries are innovating to get government aid disbursed faster is covidcredit.uk. Built by a group of UK-based fintech entrepreneurs, including the CEO of Credit Kudos, this proof-of-concept website aims to help the self-employed quickly prove a loss of income to the UK government. It’s unlikely to make much of a difference in the near term, but it exemplifies a potential solution that governments may need.
Fintech companies could be hugely beneficial in future efforts to quickly disperse SBA funds. For now, B2B fintech companies have an opportunity to strengthen existing relationships, capture additional SMB customers, and showcase how their technology exceeds that of incumbent providers.