How is FinTech helping to bridge the SME funding gap?

FinTechs like Funding Options provide small businesses with fundraising options beyond traditional bank loans

Small and medium-sized enterprises (SMEs) are often referred to as engines of growth, given their role as job creators in both developed and emerging market countries. Their contribution to economic growth often goes unrecognised but is of vital importance.

According to the World Bank, SMEs represent around 90% of businesses and more than 50% of employment worldwide. Yet these businesses still struggle to get access to finance, which can be the difference between a small business thriving, surviving, or having to cease operating entirely as their ability to scale or meet new demand is cut short by a lack of funding.

This puts them at a distinct disadvantage versus large corporates, which typically are able to secure funding for investment from mainstream lenders. Liam Gray, fintech lead at Tech Nation, offers an explanation.

“The reason why SMEs find it so difficult to get capital from traditional lenders is because the lenders look at traditional metrics,” he says.

“And if the company has only been around for a few years or a few months, it can’t prove its creditworthiness in the same way that an organisation that has been around for decades can.”

In the report The battle for business wallets, Adrian Blair, chief executive of Receipt Bank, suggests that many small businesses fail within their first five years because they are unable to get on top of their finances.

Mark Stephens, chief executive of Allica Bank, says that, historically, it has been hard for SMEs to know where to go to raise finance.

“A lot of them have just done it via an overdraft if that’s been available, or they have had to get money from family and friends, or they get it from the supplier – but that’s quite expensive,” he explains.

Formalised funding

However, if an SME is to have longevity, there needs to be a more formal route to funding than the founders simply relying on their own savings, or dipping into their families’ funds.

Mr Stephens says that the crux of the matter is that it takes SMEs a long time to know where to go and where to get the best value for money.

This results in what is known as the funding gap, which is enormous and is most acute in developing countries. The International Finance Corporation, sister organisation of the World Bank, estimates that 65 million firms, or 40% of formal micro, small and medium enterprises in developing countries, have an unmet financing need of $5.2tn every year.

Part of the reason for this is that large banking organisations have not always been able to meet SMEs’ sometimes immediate need to unlock additional financing.

Ben Brabyn, campaign coordinator at GenieShares, explains: “Banks have to consider what happens when things go wrong, so they are looking for security. And the typical SME now has fewer securitisable assets than would have been the case 20 years ago.”

But in some developing economies, businesses do not even have access to the most basic business banking services to begin with. Ekechi Nwokah is chief executive of Migo, which assists banks in lending to SMEs and works exclusively in the developing economies of Brazil and Nigeria.

“I think their [SMEs’] perception is banks are not interested in giving them money and they’re looking for who else might be able to help them fulfil their dream,” he notes. But he also stresses that he has never met a bank that does not want to give loans to small businesses. He identifies that one of the factors preventing banks from offering credit is cost structure, which makes it difficult for them to serve lots of small businesses at scale

“It is expensive to process the loan and service the loan for a small business where the bank is not making much profit,” he explains.

Migo’s platform helps SMEs in Nigeria and Brazil to access credit through a proprietary credit assessment

Reducing costs

That is where fintechs come in, Mr Nwokah adds; their cutting-edge technology lowers the costs of delivering credit in a way that, traditionally, banks have not been able to. With the ability to collect and analyse myriad data points, fintechs are helping to find a way around SMEs’ insufficient credit history or lack of securitisable assets to help plug that funding gap.

Tech Nation’s Mr Gray cites lending-as-a-service platform Trade Ledger as an example, with its real-time analysis of SME lending risk, using APIs and open banking in order to get this information. “They are taking in so many more data points than traditional lenders may be taking into account,” he explains.

“It’s a fundamental change in the way that you’re assessing risk. So there’s a process change and a technological change there,” Mr Gray says.

“That’s what a lot of the new fintechs that are coming into the market and servicing SMEs are doing. They are realising there are other ways to access creditworthiness than traditional lenders have looked at in the past.”

Whether the rise of fintechs has levelled the playing field for SMEs is up for debate, though.

“I think saying it has levelled the playing field would be a little premature. But I think we are approaching it,” notes Mr Gray.

Lucy Liu, president and co-founder of Airwallex, says that fintechs offering cross-border payment and collection capabilities have indeed levelled the playing field for SMEs.

“Take, for example, an Australian business owner who wants to set up a US online store and will require a US bank account,” she explains. “Like many other international bank accounts this can usually take many months to set up and require mandatory local identification in-person, which isn’t always feasible, especially during these times.

“With Airwallex, the Australian business can create international bank accounts within seconds and, as a result, immediately expand its customer base internationally.”

“We have celebrated the agility and speed of fintechs, [but] we should also recognise there are risks associated with innovation,” according to Mr Brabyn. “Not all these experiments will stand the test of a significant downturn.”

FinTechs like InstaRem are bringing down the cost of doing international business for SMEs

Testing times

The Covid-19 pandemic is likely to prove a testing time for even the better-funded SMEs.

According to a JP Morgan Chase & Co report published in September 2016, Cash is King: Flows, balances and buffer days, the medial small business holds a cash buffer, a key indicator of a business’ financial health, of just 27 days. 25% of small businesses have fewer than 13 cash buffer days in reserve; only 25% hold more than 62. The report flags that “many small businesses may not have enough cash to continue operations in the face of a month-long loss of cash inflows due to an economic downturn or other negative shock”.

Mr Stephens explains: “Most SMEs only carry sufficient cash for a relatively short period of time for survival. If they can’t get cash through the door, do business, get the invoices out, and get paid, their survival period is actually quite short.”

He predicts that the damage to the SME sector from the pandemic will be quite significant. But Ms Liu suggests fintechs will be an enabler. “As conserving cash flow becomes extremely important during these times, businesses will be more willing to explore alternatives to the traditional banks for better rates, as well as the ability to set up and manage their bank accounts online.”

Mr Nwokah agrees fintechs fulfil an important role at a time like this.

“I do think there is a great need for credit because of a slowdown in [SMEs’] normal business flow and activity. Fintechs like us and many others are really needed, frankly, to prevent job losses. If they do not get access to this credit, they close down.”