Small and mid-sized companies are vital to the prosperity of the U.S. economy. Yet many struggle to secure the financing needed to grow their businesses. Access to financing has improved to some extent in the recent years as have the options with the influx of online small business lenders. Still, a critical funding gap is putting smaller businesses at competitive risk.
One solution for expanding financing for small and medium-sized business enterprises (SMBs or SMEs) is the greater emphasis on asset-based financing models and lending decisions that favor cash flow over credit scoring. More finance companies should adopt asset-based funding models.
Secondly, the readily available technology can make SMBs a more attractive sector to target for funders. Outdated, manual back-office processes inflate the costs of handling transactions, so much so that the small-ticket transactions become just as expensive to process as the larger ones and therefore are less profitable. Technologies are available to process these transactions more quickly, efficiently and cost-effectively. It is time for the industry that is perhaps best equipped to increase funding to SMBs – equipment leasing and finance – to embrace these technologies.
Small but Mighty
The U.S. has an estimated 30 million SMBs. They are a major force, responsible for generating close to two-thirds of the net new private sector jobs in the recent decades. Of those companies, small firms employ nearly 50% of the private sector workforce. But the rate of new businesses being created has been declining for the past 30 years and has only partially recovered from the Great Recession, according to a Harvard Business School working paper.
Problems in accessing financing are stalling start-ups and shelving SMB growth plans for some companies. This sector is significantly underserved by the funders, and SMB capital investment is also much higher than it is for their larger peers. SMBs don’t have easy access to banking channels, and even with more small-business-oriented credit unions and community banks in the U.S. banking system, the coverage is inadequate.
While the financing landscape for SMBs has been improving, the funding gap is still significant. The Federal Reserve Banks’ 2017 Small Business Credit Survey estimated that 46% of the companies received the full amount requested in 2017, compared to 40% in 2016. “Forty-four percent of firms with low credit risk experienced a financing gap, compared to 71% of medium credit risk firms and 90% of firms with high credit risk. Firms most frequently attributed these shortfalls to insufficient credit histories and insufficient collateral.”
Narrowing the Financing Gap
Asset-based finance models and lending decisions that favor cash flows over credit scoring can increase funding available for SMBs. This is a better measure of a company’s ability to pay down a lease or loan, but most banks and finance companies remain overly focused on credit. Loan or lease contracts in asset-based financial models are based primarily on asset usage or equipment pledged as collateral. The lender then can sell the assets if needed to recover the losses. We recently explored this topic in a blog post focused on the UK, but the basic information on asset-based financing will resonate with readers on both sides of the pond.
Additionally, the $1 trillion equipment leasing and finance industry in the U.S. is an important source of funding for SMBs Small-ticket transactions, defined as up to $250,000, represented 30% of new business volume for the industry in 2016, according to the Equipment Leasing and Finance Association (ELFA).
Narrowing the Technology Gap
The average SMB needs a loan or lease for a far smaller amount than $250,000. And that’s where another kind of gap – the technology gap at financing companies – becomes a problem.
Nearly 60% of small businesses seeking financing are applying for transactions under $100,000, the Harvard Business School paper authors wrote in a follow-up article. Transaction costs associated with making a $100,000 loan are nearly the same as those for a $1 million loan, so some banks naturally favor applicants seeking higher loan amounts. “In addition to improving the experience for business owners, digitization has the potential to substantially reduce the cost of lending at every stage of the process, making SME customers more profitable for lenders, and creating opportunities to serve a broader swath of SMEs. This is important because transaction costs in SME lending can be formidable….,” the authors wrote. Other thought leaders including Accion Venture Lab have also urged funders to leverage technologies to reduce overhead in serving SMBs.
So where does the equipment leasing and finance industry fall into the digitization spectrum? Most lessors and lease management systems lag behind other financial services such as B2C and B2B loan and asset management providers in their adoption of digital capabilities, according to a global benchmark study by The Alta Group that was recently covered in the Monitor. Less than 5% of lessors, for example, are using electronic identity, e-signature, and e-documents, though more than half are planning to implement these technologies. Most current digitization efforts in the industry are focused on customer-facing processes.
“There is clearly a strong emphasis on investing in the front office and especially the customer relationship and experience while nearly half the organizations surveyed are in the process of digitalizing their sales and marketing functions. Digitalization was also being widely applied to streamline business processes and support process re-engineering, though for most this was still a work in progress,” the study summary noted.
So, we have a duck-on-water situation in equipment leasing. On the surface, a leasing company can demonstrate efficient automation and e-commerce in its dealings with customers, but underneath it may be scrambling. Processes still handled manually in some companies that can easily be streamlined using available technologies include credit approval, identity verification, fraud checks, documentation generation and signatures.
Here’s one example of labor-intensive processes ripe for automation: the manual review of every credit application to ensure data provided by the customer are accurate. Using available technology, lessors can automatically convert the data provided by customers into a credit application (no manual entry), submit it automatically for identity verification (no manual verification), automate address validation (eliminate invalid addresses), automate credit pull and scoring (minimize manual credit review to exceptions only), automate document generation (no manual docs) and send documents for e-signatures (eliminates receiving back physical signed documents). Automating these processes alone can reduce the overall time for processing a credit application from days or weeks, to minutes.
Today’s technology tools can increase the efficiency of processing the transactions for SMB customers so that doing business with them is more lucrative for funders. They also can expand options for usage-based billing, making financing more affordable for smaller businesses and at the same time improving a lessor’s competitiveness.
“Technological change appears to be advancing so rapidly that simply staying in place and adhering to traditional models may no longer be a feasible business strategy for some firms,” the ELFA State of the Equipment Finance Industry report observed. “Increasingly, equipment finance providers that adopt these technologies are likely to gain an edge over those that don’t.”
Capturing a Growing Market
The SMB market is indeed an attractive one for equipment finance companies that are leveraging the right technology. A recent study by the National Federation of Independent Businesses (NFIB) shows historic levels of optimism and hiring plans that, in turn, should increase demand for leased equipment needed to support that growth.
“Small business owners are leading this economy and expressing optimism rivaling the highest levels in history,” said NFIB President and CEO Juanita Duggan. “Expansion continues to be a priority for small businesses who show no signs of slowing as they anticipate more sales and better business conditions.”
Executive Vice President-lease
Cloud Lending Solutions