When it happens, be ready for a painful and significant slowdown in small business financing.
For small business owners, raising capital has never been as easy as it is today. Banks have eased credit to small businesses. Fintech startups are expanding online lending options. And business lending opportunities have looked so promising even tech giants, such as Amazon, Square and Paypal, have entered the market.
But another recession, which many say could hit even this year, could put an end to all that.
How the next downturn will play out is hard to predict. I’ve shared my thoughts on what entrepreneurs should do to make sure their small businesses are recession-proof. An important tip is to be well capitalized. You should take steps to build and strengthen your credit history and, if possible, lock in capital now. Remember when economy is good, capital is available to almost everyone. In bad times, it’s available only to those with the best credit and track record in managing their finances.
This is important to keep in mind as you prepare for what will be one of the biggest hurdles for small businesses in the event of another downturn: a likely painful and significant slowdown in small business financing.
That’s what happened a decade ago during the Great Recession. Bank loans dried up and many small businesses went under. Eventually, the economy and small businesses bounced back. Community and regional banks played an important role in this recovery, which also saw the rise of new players in small business financing. These include online business lenders that are part of the so-called fintech revolution. My company, BlueVine, is one of them.
Here’s the bad news if there’s another downturn. Despite having more options today, another recession will likely cause a serious disruption in small business lending. In fact, a credit crunch could be more prolonged for small business owners in the next crisis.
One reason is community banks have gone through a major consolidation period that saw many of them either acquired or shut down, so there are fewer of them to lead another recovery.
Meanwhile, the big banks, like in the past, will likely scale back small business lending dramatically. In addition, the tech companies that pursued opportunities in small business financing may pull out of that market at first signs of credit losses.
The ability of fintech small business lenders to face this crisis successfully will depend on three factors:
1. Secure capital.
As with small businesses, a key to fintech lender survival and success is having enough capital to weather the storm. This is important even in good times. Fintech players such as Dealstruck and BizFi went under or stalled due to inadequate financing.
2. Offer multiple products.
Another key is having multiple products. As I’ve said in the past, the days of one-trick ponies in fintech are numbered. Having different types of financing products will be a major strength as lenders seek to address diverse financing needs of small businesses at a time when credit is tight.
Having more products also allows the lender to be more flexible by adjusting their product offerings to the changing credit conditions. For example, invoice factoring is a really good product for when the cycle changes because the financing company is not taking on small business credit risk. They are taking on payor risk. It’s a very resilient credit structure in a down market.
Long term financing, such as multi-year term loans, are riskier in a down market. But being able to offer that as an option will be important as the market recovers and more small businesses seek capital for growth and expansion.
3. Manage risk very closely.
Managing risk is core to the financing industry. This will be even more critical in a downturn. Having solid capabilities in data science and analytics, including having in place an experienced, world-class risk analytics team, gives you an advantage in identifying macro trends. Furthermore, it is important to use predictive analytics in looking at the overall health of the portfolio — not just the single client that you’re underwriting in order to see the overall trends.
Artificial intelligence and machine learning have become the building blocks for credit models. But that is not enough. The ability to quickly update and adapt your models in a changing credit environment will become critical. Credit models that have worked well in a growing economy may completely fall apart in a recession.
There’s been a lot of talk that the fintech lenders have not really been tested. Well, the coming downturn will change that. The fintech lenders that go into this cycle and are able to move past the crisis are going to come out stronger.
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