Powerhouse e-commerce companies begin to offer small business loans. What does this mean for traditional banks?
If banking bigwigs and fintech entrepreneurs have seemed a bit queasy since October’s Lendit Europe conference, they might be blaming Karen Mills for daring to illuminate the elephants in the room: Amazon and Google, and their ability to disrupt the small business lending industry.
Mills, a former White House administrator for small business and current Harvard Business Review fellow, succinctly pointed out the obvious. With the tremendous amount of financial and personal data these behemoths collect, a broadening of scope into small business lending may be inevitable.
"If you think about what Amazon already knows about its merchants, and then you think what Google knows about everybody who is buying and selling through its platform, one can imagine a world where they have much more information about both on the credit side but also on the small business itself,” she said.
While Google hasn’t made any notable overtures into the lending business yet, Amazon launched its lending business to support its merchants in 2012. As reported by Bloomberg, the retailer issued $1 billion in loans in the 12 months between May 2016 and June 2017. To date, they have extended $3 billion to over 20,000 small businesses here, as well as in the U.K. and Japan.
The Magnificence of Micro Loans
Supporting creditworthy merchants isn’t new. Merchant services provider Square has given its merchants loans of over $1.5 billion since its in inception in 2014, and PayPal’s Working Capital program has loaned over 115,000 global businesses a total of $3 billion.
Dubbed micro loans, these low-amount loans give small business owners access to the capital they need to get up and running. Micro loans typically range from $500 to $500,000, with some reaching into the low millions.
Amazon and Square merchants repay the loans automatically based on the amount of sales they make. PayPal’s maximum small business loan amount is 30 percent of a merchant’s annual PayPal sales, not to exceed $97,000 for the first loan.
"If you look at the small business hierarchy needs, they need access to cash, funds, they need time, and they need more sales. And what if you were able to provide an efficient system that gave them more time to do all their work, access to capital and something that boosts their sales line? You could see how that player could win over a traditional player or even a new fintech,” Mills explained at Lendit Europe.
Two of the biggest new fintech lenders, Lending Club and OnDeck, are struggling to recover from tepid second-quarter results that have yet to meet the dizzying expectations of their IPOs. OnDeck has rejiggered its business model, dropping its online marketplace lending strategy to work more like a traditional bank, and Lending Club is facing competition from traditional financial institutions willing to make the same kind of unstructured loans that Lending Club makes.
Some sector analysts suspect that to survive, online banking operations will need to remodel themselves into more traditional banking structures.
The Sweet Spot for Small Business Loans
Last year, Deloitte expressed doubt that online lenders would eclipse traditional banks, arguing that with a little effort and attention to digital tech trends, traditional banks can easily rule the day.
A new McKinsey report points out that not only do traditional banks have exclusive access to a tremendous amount of very valuable customer data, they also have access to digital technologies that will enable them to outpace the upstarts—eventually.
“Already we are seeing early success stories from around the world, as banks start to develop platform capabilities. It is not too farfetched to imagine a day when banks will offer a range of services, reach a vastly larger customer base, and succeed at their digital rivals’ game,” the report stated.
Both analyst reports focused strictly on mass market banking with little to no attention given to small business lenders.
Nearly everyone who has attempted to acquire a small business loan has taken a heart-sickening trip to the Land of No: banks and VCs. A lack of demonstrable revenue, a lack of inventory or other assets, and poor or shaky credit history keep thousands of small biz loan applicants out in the cold every year.
Small business loans may not seem risky from the applicant’s perspective, but traditional lending institutions are tied to their margins, and low-amount loans just don’t generate enough revenue.
Small Business Domination
That’s where merchant-based small business lending programs will truly disrupt the landscape. By allowing business owners to pay back loans directly from sales revenue, programs like Amazon, PayPal, and Square are filling a niche that the economy needs—and that traditional lenders don’t want to touch.
Small businesses account for roughly 99.9 percent of all businesses in the U.S., and are responsible for 61.8 percent of the new jobs established from Q1 1993 to Q3 2016. About 80 percent of the nation’s 29.6 million small businesses are nonemployers.
Over time, successful micro lenders might whittle away at the risk-averse traditional lending system, but don’t get too excited about that just yet—the agencies that oversee small business lending regulations haven’t begun to scratch the surface of this potential new reality.
Bringing that Balkanized group to consensus will certainly be tougher than getting a small business loan on the strength of a great idea.
Regulatory hurdles aside, Amazon and other truly disruptive merchant lenders have rightly honed in on a strong segment of American business, and the flexibility, acceptance, and trust they extend will certainly strengthen it more.
As Karen Mills reminded conference attendees, “Amazon has clearly signaled they're going to provide at least financing for their merchants that they know. And that's very smart."