Small businesses represent 99.9% of American firms, yet effectively financing them remains an ongoing challenge.
Small businesses are inherently risky — and many end up being short-lived operations. And while the demand for innovative lending solutions tailored for small and-medium-sized businesses (SMBs) continues to grow, traditional lenders, particularly large banks, frequently view SMB lending as resource-intensive and unprofitable, and as a result shy away from the space.
But with the news from the U.S. Census Bureau that almost 5.5 million new U.S. business applications were filed in 2023, breaking the 2021 record of 5.4 million, capturing the opportunity this represents for smaller banks and community lenders like credit unions is top of mind for those financial institutions’ executives.
After all, SMB lending is a multifaceted puzzle, not a commodifiable offering — which is why community financial institutions are uniquely positioned to capture the small business lending market. With an inherent understanding of their local economies and a personal touch that larger banks often lack, these lenders can find themselves with a competitive edge in their local markets.
And when it comes to the specialized needs of SMBs, taking a specialized — rather than generalized — approach to lending can be the strategy that ultimately pays off.
Read more: The $150B Question: Can Community FIs Capture the SMB Digital Banking Opportunity?
To fully seize the SMB lending opportunity, alternative lenders must themselves embrace digital transformation.
As technology continues to evolve and industries become more specialized, the ability to understand and meet the unique needs of small businesses will be a key differentiator. Small businesses, especially startups, often lack the robust financial histories and credit profiles that lenders rely on to assess risk. The absence of substantial collateral and established cash flows makes it difficult for lenders to confidently gauge the likelihood of repayment. This perceived risk is exacerbated by economic downturns, which can disproportionately impact smaller enterprises.
As recent PYMNTS Intelligence noted, 71% of SMBs are experiencing cash shortfalls.
Unlike large corporations, small businesses exhibit diverse needs and business models. This diversity means that a one-size-fits-all approach to lending is inadequate. Each business may require tailored financial products, such as lines of credit, term loans, or equipment financing, each with different risk profiles and return potential.
Only about 8.5% of SMBs have found working capital loans from banks to be readily available, according to “What’s Next in Credit: Why SMBs Prefer Corporate Credit Cards for Short-Term Financing,” a PYMNTS Intelligence and Cross River collaboration.
Many small businesses do not have sophisticated financial systems or the ability to provide detailed, accurate financial statements. This creates information asymmetry, where lenders cannot accurately assess the health and potential of a business. This challenge is particularly acute for non-traditional or niche businesses that do not fit into standard industry categories.
The PYMNTS Intelligence report, “The $150B Question: Can Community FIs Capture the SMB Digital Banking Opportunity?,” done in collaboration with NCR Voyix, provides insights into the evolving financial landscape for SMBs and finds that many SMBs are ready to switch to institutions that offer modern digital tools.
See also: How Businesses Leverage Working Capital Solutions to Drive Growth
The cost of underwriting and processing loans for small businesses is relatively high compared to the loan amounts. For traditional banks, this means lower profitability per loan, disincentivizing them from focusing on the small business segment.
But embracing a specialist approach allows lenders to offer SMBs customized financial products that meet their specific needs. This might include flexible repayment terms, working capital loans that align with seasonal cash flows or financing options that take into account the growth trajectory of a startup. Such tailored solutions can significantly improve the likelihood of a business succeeding and repaying its loan.
Jennifer Marriner, EVP, GlobalAcceptance Solutions at Mastercard, told PYMNTS that SMBs are a significant focus within the embedded finance landscape. She noted that SMBs are particularly attracted to embedded finance as it offers a straightforward way to access financial services through the platforms that they already use for other business operations, such as accounting and inventory management.
The difficulties associated with small business lending are well-documented, but they are not insurmountable. A specialist approach, characterized by industry expertise, advanced data analytics, customized solutions and strong relationships, offers a viable path forward. And by focusing on the needs of small business owners and leveraging technology, lenders can not only expand their portfolios but also contribute to the broader economic environment.
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