Flo talks about responsible lending to small businesses
SME borrowers today face an interesting conundrum. While the number of sources that can facilitate access to capital may decline, the number of financial products available on the market today designed for SMEs continues to grow.
Although small business owners are smart, they are busy and often lack the time to fully educate themselves on the most suitable products for their unique needs. Flo Co-founder Ryan Ridgway told PYMNTS what he expects to see in the SME landscape over the coming months, and the importance for financial service providers to work with borrowers to increase understanding and awareness of ready product choice.
Without a well-educated borrower, he warned, bad actors can jump at the chance to step in and connect SMEs with capital that could do more harm than good.
What awaits us
During the past year, the introduction of the Paycheque Protection Program (PPP) revealed how crucial it is for alternative lenders to provide a user-friendly, digital-first experience for SME borrowers.
But when the PPP initiative inevitably ends, what will remain could be an ecosystem of traditional lenders with no risk appetite to finance SMEs, and a community of FinTechs that may be slow to fill the void.
“Many business loan markets have completely suspended funding or tightened their underwriting criteria,” Ridgway said. “Most of them are almost exclusively P3 focused. These funds will be used up at the end of April, beginning of May, which happens very quickly. What concerns me is that some of these lenders may have turned to P3 so heavily and might be slow to re-enter the market. “
There is also likely to be market consolidation ahead, he predicted. As more banks and non-bank lenders begin to integrate the same types of technologies, whether it’s Plaid’s data aggregation capabilities or Know Your Customer (KYC) and tools. integration automation from other technology vendors, Ridgway said it expects more players in the industry to find value. by merging.
With this in mind, SMEs may eventually find that there are fewer sources of capital to contact when needed. But what is of more concern to Ridgway is the threat SMEs face from not being able to access the right kind of capital.
The bait and the switch
From supply chain finance to revolving line of credit, the list of finance products designed for SMEs is long. And not all products are suitable for all use cases.
There is often a bait-and-swap tactic that some loan companies use to capture business, Ridgway noted.
“Even space holders can swing the carrot with a particular product, only to unfortunately put a merchant or borrower in a different product, which may not be good for their business,” he said.
This different product, he continued, is often the merchant cash advance (MCA). It is a tool that has, in recent years, attracted negative attention, sometimes equated with payday lending from the borrowing world of SMEs.
It’s not that the MCA is inherently bad, Ridgway said. For a high margin business, the MCA can indeed be a tool that supports growth and can connect businesses to much needed working capital. The problem arises when a small-margin SME is pushed into the MCA under the guise of affordable tariffs.
Actors in the transport or construction space, for example, are rarely a good fit for the MCA thanks to a low frequency of deposits.
“It’s not really fair to look at the income of this business on a monthly basis,” he added. “They are siphoned off in these daily cash advances with exorbitant rates, and [MCAs] end up doing more harm than good.
In another example of how SME loans may not match the borrower, Ridgway highlighted cases where SMEs, seeking to fund a three-month marketing blitz, are being pushed into a credit instrument. which may require repayment for years to come.
Other potential pitfalls arise when a company announces attractive terms to attract a business borrower, only to change what is actually available to that SME. As Ridgway explained, these rates are advertised simply as a way to start a conversation with a small business.
“A lot of it is just smoke and mirrors and marketing, and a way to get a customer,” he noted.
Often, SMEs don’t even know exactly what kind of products they need for their particular scenario. This creates a vast opportunity for the SME lending industry to continue its efforts towards a better borrowing experience, not only through digitization and speed, but also through a more ethical approach to financing. Ridgway said it will require an effort on the part of lenders to educate the borrowing community, as well as for brokers to take more responsibility in the funding process.
“There needs to be more accountability,” he said. “Helping small businesses to diffuse between different credit instruments and correlate them to the use case of funds is a really important thing that needs to be done. “