Digital Lending for SMEs

Since the 2008 recession, well-known banks have been awarding fewer loans to small and medium-sized
enterprises, and other firms have started appearing to fill the void. Three interesting business models
that are worth exploring are innovative short-term working capital, peer-to-business lending, and
invoice financing.

Short Term Working Capital

For companies looking for short-term loans with quick delivery, Fintech is good news. Up until a few
years ago, there were no suitable alternatives to banks. Companies would end up having to request
merchant cash advances, receiving a lump sum in exchange for a share of their daily credit card sales.
Effective interest rates would be over 100 percentile points, making them very expensive. Companies
such as Kabbage, OnDeck and PayPal Working Capital have introduced low-cost alternatives.

These companies require a certain number of months of credit history, a certain turnover, and they will
also look at the personal credit score of the owners. The good thing is that there is almost no
paperwork, and everything is done online. PayPal is the easiest company to qualify for and has good
rates. However, borrowers need to be selling through PayPal. Kabbage is the next easiest, and OnDeck is
the most restrictive of the three. OnDeck requires personal guarantees, meaning that you are pledging
your personal finances to pay back the loan.

The companies will tap into applicants’ sales details from different sources such as Shopify, eBay,
Amazon, Xero accounting, etc., to gain a clear view of your profitability.

Traditional banks are taking note of these innovations. For example, JP Morgan Chase collaborated with
OnDeck to add an online lending platform to its conventional underwriting process. Kabbage also forged
a similar partnership with Spain’s ING and the UK’s Santander to provide the platform for the banks’
delivery and underwriting services.

Peer-to-Business Loans

Because of banks’ restrictions to lending, some businesses do not have access to credit. Peer-to-business
offers an alternative to this problem by providing an opportunity for investors to earn money. At the
same time, it allows for businesses to acquire their much-needed funding. Businesses get funds quickly
and at a lower interest rate, whilst lenders receive a higher profit from their investments. Banks cannot
offer the same high margin to depositors, as their structures are costly.

In the United Kingdom, the Financial Conduct Authority started regulating peer- to-peer lending,
including business lending, in April 2014, to protect consumers and supervise and guide related anti-
money laundering measures, promotions, and other activities. Peer-to-peer lending firms now have
base capital requirements that have to be reported monthly to the FCA. The FCA also requires peer-to-
peer lending platforms to follow the Client Money Rules in the FCA Handbook to protect lenders’ money
and comply with disclosure requirements

The auction P2B lending model means a borrower can initiate a loan by specifying the amount and the
date of repayment desired. Then, lenders try to outbid each other, offering an interest rate they feel will
mitigate their risks. At the end of the auction period, the borrower can decide whether or not to accept
the loan, depending on the average interest rate. They pay for the loan monthly with the added interest.

If the borrower does not repay the loan on time or defaults, lenders lose their money. Thus, they need
to take the necessary precautions by scrutinising each loan and asking the borrower questions. They can
also spread their investments by funding several small loans. They can opt not to lend their money if
they feel that a borrower is too risky.

In the United Kingdom, Octopus Investments entered the peer-to-peer lending business in April 2016
with at least £5.5 billion in assets. It offers investors a discretionary portfolio of asset-backed loans from
Octopus Property

Established in 2009, Octopus Property (formerly Dragonfly) had about 3,500 borrowers with a loss rate
of 0.1%. Octopus’s loan origination is of the highest quality, and it has a reliable underwriting process.
Octopus views the peer-to- peer lending model as having strategic value because of the innovative
investment model.

Invoice Financing

Invoice financing can consist of invoice factoring, invoice trading, or invoice discounting.

With factoring, an invoice financier will manage the sales ledger to collect money owed to a company.
Factoring allows companies to grow by generating funds to keep the business afloat whilst waiting for
the customers’ payments. Usually, the third party or factor pays between 70% and 90% of total accounts
, and customers make their payments to the factor. Then, the factor remits the balance to the business
less its service fee.

The factor will first assess the creditworthiness of the customers before it accepts the accounts. It is not
a collection agency, but customers must have good credit standing. It may also consider the yearly
revenues and how many years the business has been operating for before agreeing to provide the
factoring service.

The factor will request payment from the customers after checking the accounts receivable for
completeness and accuracy. Upon receiving payment, it will move the balance of the invoices back to
the business owner. Other factors charge fees and pay the business owner 100% of the total value of the
invoice. Some factors allow the business to collect the payments and receive the repayments plus fees
when the customers pay.
Before technological disruption, banks were the only ones providing factoring. However, the
introduction of technology allows for a different product, invoice trading. Instead of managing the
whole sales book, companies can select which invoices are sold to financiers. By placing these invoices
on a platform, individual investors can invest, in a similar fashion to peer-to-peer lending. Players such
as Market Invoice and Platform Black have entered the market, bringing in crowdsourcing platforms to
provide invoice factoring, invoice trading, and invoice discounting services.

Supplier chain finance is another option for fund purchasing. In this type of financing, a company
registers with a platform, provides information about invoices that require payment to suppliers, and
issues a promise to pay. The platform will then look for funders to pay the invoice in a competitive
bidding process. The suppliers will receive immediate payment, and the company gains breathing space.

Key Players

Founded in 2009 by Marc Gorlin, Rob Frohwein, and Kathryn Petralia, Kabbageoffers a technology and
data platform for business loans. It can connect directly to QuickBooks, PayPal, banks, and even social
media to assess the creditworthiness of a prospective borrower. A borrower only has to wait about six
minutes to find out if they qualify for a loan. However, the convenience and speed of approval come at a
price

Kabbage can provide a borrower with a maximum of $100,000, payable in six months. On average, a
borrower might take out eight loans yearly for a total of $50,000. Kabbage is one of the top alternative
lenders in the US. It attracts investors because of its low loan default rate. It offers loans to established
businesses using an automated model that assesses character, capacity to repay, and business stability
and consistency. It uses non-traditional metrics like the prospective borrower’s online reviews and social
media followers.

In 2012, Kabbage became part of Red Herring’s Top 100 North American private enterprises. In 2014 and
2015, Forbes Magazine named it as one of Top 100 Most Promising Companies. In 2016, CNBC name
Kabbage as one of its annual Disruptor 50 for being ambitious and forward thinking, revolutionising
markets and industries worldwide.

OnDeck went public in the NYSE December 2013, with the aim of offering online loans to small
businesses. With its headquarters in New York City, it has provided loans to 30,000 small businesses
since its inception in 2007. In 2014, it reported gross revenue of $158 million, with net revenue of $73
million average, an OnDeck loan has a 51.2% APR.
PayPal Working Capital is for PayPal users who want a fixed and affordable business loan. A borrower
pays the fees and pays back the loan through their PayPal sales. However, they do not pay any penalty
fees, prepayment fees, late fees, monthly bills, or interest charges. The maximum amount they can
borrow depends on the sales history of their PayPal account. Loan approval only takes minutes, and the
money goes to their PayPal account instantly.

PayPal ensures that the borrower repays at least 10% of their loan, plus a fixed fee, every three months
for the 18 months of the loan term, or until the borrower has repaid the loan in full. Only one loan can
be taken out at a time. The borrower needs to pay their loan in full before they can apply for another
loan

PayPal Working Capital started as an invite-only pilot in September 2013 and later collaborated with
WebBank to expand the business. According to PayPal’s VP for SMB Lending, Darrell Esch, the fact that
its customers’ sales histories drive credit decisions in approving instant business loans makes it unique

San Francisco-based Square Capital is a fast-growing lending company, founded by Jack Dorsey, also a
co-founder of Twitter. In 2014, it launched a cash advance service for merchants that use the company’s
POS system. It used the merchant’s cash flow and sales data to determine if the merchant qualified for a
loan. It is now expanding its services to include online loans with fees of between 10% and 16% of the
total loan amount

Collaborating with Upserve, a startup offering software and POS in the restaurant sector, Square will use
Upserve’s cash flow and anonymous sales to analyse which restaurants qualify for a loan. Eligible
restaurant businesses can take advantage of a personalised loan through the Upserve software, paying a
fixed rate of their everyday sales. In the 2nd quarter of 2016, Square provided at least $189 million in
loans to about 34,000 businesses.

Levi King and Brock Blake started Lendio in 2011 as a financial service that simplifies the process of
obtaining a loan through matching. Instead of applying for a bank loan, a small business owner can use
Lendio’s platform to look for lenders who can provide them with a business loan. Instead of competing
with companies like OnDeck, Lendio collaborates with lenders so that business owners can receive pre-
approved loans. Well-known investors in Lendio include Highway 12 Ventures, Tribeca Venture Partners,
and Runa Capital
Founded in 2014, Fundera is an online loan broker that helps small business obtain different kinds of
loans. Founded by Jared Hecht, it’s an alternative to conventional bank financing, which small
businesses find difficult to access

Fundera facilitates loans, rather than lending money, connecting borrowers and lenders through its
online platform. Each borrower can access a personal consultant who helps them with their
circumstances, and they need to have a connection with at least one lender in the network. Fundera
earns from 1.5% to 3% of the total loan amount as a finder’s fee payable by the lender.

Alibaba, together with at least 25 banks and credit rating bureaus around the world, announced that it
would make cross-border trade financing and a new credit reporting service available for small and
medium-sized enterprises. Building on the credit profiles of businesses of this size in China, Alibaba can
identify trustworthy trading partners in China for overseas customers and can also provide innovative
financing alternatives to Chinese suppliers.

Alibaba has evolved to become a one-stop shop for different services for international suppliers and
buyers, including business verification and logistics services. Currently, the loan feature is only available
to small and medium-sized Chinese enterprises. China Merchants Bank, Bank of China, and MYBank
collaborate to provide the loans for Alibaba’s customers