How Alternative Solutions Are Challenging Traditional Credit Models for SMBs

A record-breaking number of new business applications were filed in the United States last year; 5.5 million, to be exact.

While that’s a great sign for American entrepreneurship, the surge in new businesses may put traditional business lending solutions under a strain that they’re unprepared to manage.

Businesses commonly need external financing both to invest in growth and to manage unexpected daily disruptions — and often, the smaller the business is, the greater its need is.

Markaaz announced Monday (May 6) that it is creating a proprietary business health score that uses a variety of data points and metrics to score businesses within its network, with a particular focus on small- to medium-sized businesses (SMBs). The use of alternative data to help SMBs establish and grow their business with better, more streamlined access to financial services is top of mind for FinTechs, banks and other solution providers.

“Thirty percent of small businesses get rejected for basic services like credit cards, bank accounts, etc. because they can’t be verified,” Markaaz CEO Hany Fam told PYMNTS Monday. “And we see that number consistently across the whole world.”

These excessive barriers in accessing banking and credit represent a lost opportunity for financial service providers, as well as a regrettable impediment to smaller and newer businesses.

With the cost of doing business only growing more unpredictable, next-generation underwriting solutions need to, in turn, become increasingly reliable in their risk assessments of important sectors like the SMB market, which makes up 40% of the U.S. economy and represents 99.9% of all American businesses.

Read also: Open Banking Allows More SMB Data to Be Used in Financing Decisions

Making Multifaceted Decisions About SMB Credit

Securing funding for starting or expanding a business can be difficult, especially for newer firms and smaller organizations that haven’t yet established credit or collateral.

Mom-and-pop businesses with only a handful of employees “often need small loans of $100,000 or less, but not all banks offer them” — and that’s according to the White House.

Traditional credit scoring models often rely heavily on limited financial data, such as credit history and income, which may not fully capture the credit risk of SMBs. PYMNTS Intelligence’s “What’s Next in Credit: How Lack of Credit Access Impacts SMBs” found that 6 in 10 SMBs are denied access to the funding they need.

“Underwriting small businesses isn’t simple,” Ryan Rosett, co-founder and CEO at Credibly, told PYMNTS last month, explaining that while having access to working capital is “imperative” for small businesses, there is a gap in the market for alternative lenders to fill.

Alternative data sources offer a broader view of an SMB’s financial health and can help lenders make more accurate and predictive credit decisions by providing additional insights into their financial behavior, payment patterns and risk factors.

For example, analyzing cash flow patterns and transaction history can provide insights into the stability and consistency of an SMB’s revenue streams, which are indicators of creditworthiness. Similarly, examining payment behavior with suppliers and vendors can reveal the SMB’s reliability in meeting its financial obligations.

These risk factors — and underwriting opportunities — may not be captured by traditional credit scoring models.

See also: Gen Z Small Business Owners Get Personal for Business Loans

Alternative Solutions to Fund Mainstream Main Street Growth

The SMB segment faces a litany of ongoing challenges that range from economic uncertainties to regulatory burdens, to access to capital and managing the growing imperative for digital transformation.

SMBs need to assess what borrowing tools or financing solutions are right for their organizations’ needs before selecting the products that make sense for them.

PYMNTS Intelligence’s “SMB Borrowing Dynamics: Trends, Tools and Decision Drivers” found that different priorities shape the final decision. For example, while 73% of all SMBs surveyed use revolving credit, low-revenue SMBs (those earning less than $1 million annually) use fewer borrowing tools, on average, than their high-revenue counterparts (those earning $10 million or more a year). Low-revenue SMBs tend to prioritize immediate working capital needs and financial stability relatively more than high-revenue SMBs, which focus more on business expansion and growth objectives.

Because SMBs may need to both raise more money and cut down on their expenses to survive, innovations in funding solutions are vital for addressing their evolving needs.