Eight years on from the 2008 “Great Recession,” credit remains a deep challenge to the small and mid-size enterprises (SMEs) that fuel what is still the world’s largest economy. Combined with the effect of multi-national corporations (MNCs) squeezing supply chains, the issue continues to weigh on America’s ranks of smaller firms.
The importance of that weight should not be underestimated. Every year since 2000, America’s SMEs have accounted for between 45% and 50% of private non-farm gross domestic product (GDP). According to US government agency the Small Business Administration (SBA), employer firms with fewer than 500 employees account for over 99% of businesses and 63% of new job creation. Without a proper system that supports a company’s “cash to cash” cycle, the time between the outlay for costs necessary to run a business and the receipt of payments from the output of those costs, SMEs will continue to struggle to meet their current demand curves, let alone be positioned for future growth.
Any company’s lifeblood is its cash to cash cycle. Whether it is a distributor waiting on his finished goods en route from China or Mexico, or a manufacturer who has steel sitting on his inventory floor, business owners are constantly managing cash that is tied up in the production of their goods and services. This is especially true of SMEs, which do not reap the benefits of certain economies of scale that a larger firm may achieve. Putting in place a flexible working capital solution is not only critical for today, but also paramount for positioning a company for growth in the future.
A long-standing problem
Access to capital for America’s SMEs was already in steady decline at traditional financial institutions prior to the financial crisis and has not recovered since. This fact was highlighted by Karen Mills, former SBA administrator and a member of President Obama’s cabinet, in her exceptional Harvard Business School white paper from July 2014, ‘The State of Small Business Lending: Credit Access During the Recovery and how Technology may Change the Game’.
Banks, the historic lender to SMEs, have been limited by the regulatory overlays, including higher capital and liquidity requirements. The need to deleverage has caused financial intermediaries to significantly scale back lending, resulting in a credit crunch and tighter borrowing constraint for businesses, especially SMEs. According to the Federal Reserve, commercial bank SME loan growth from 2003 to 2007 was 10.5%; however, from 2007 to 2011 it shrank to 2.1%.
The toll on manufacturing companies was specifically troubling. A National Federation of Independent Business (NFIB) study from 2012 showed that, of all types of credit, only 29% of SME manufacturing companies had business loans on their books. The other 71% had to resort to alternative forms of credit, often to the detriment of profitability and the company as a whole.
This exit of traditional sources of credit has been exacerbated by large companies putting the squeeze on their supply chain by unilaterally extending out payments to suppliers for goods and services received. This is not done out of any malice, but merely a realisation of larger firms’ financial footing and the desire to manage their own working capital needs.
The unfortunate bottom line for SMEs is a combination of reduced access to historic sources of financing at reasonable terms and costs, and a slow-down in payments from their largest buyers. As such, small business owners and chief financial officers (CFOs) are spending more and more of their time on short-term Band-Aids, which means less time on the operational side. Solving for a medium to long-term capital structure will relieve this burden, and better equip the company for sustainable growth.
This capital structure optimisation, and the corresponding impact on cash-to-cash cycle, can now be satisfied by online lenders. Today, the small and mid-size business alternative lending landscape in the US primarily falls in two categories:
Whatever the name du jour, these companies use technology and data to create a direct connection between SME borrowers and private capital. By breaking down geographic boundaries and removing physical constraints, the wealth of these options now available to SMEs continues to grow. Whether it be the owner of a restaurant looking for a $200k term loan to help with operating capital, or an aerospace parts company seeking a $2m line of credit for growth capital, the opportunity to access capital in a seamless manner is just a click away.
Furthermore, these lenders are being proactive in opening up areas of distribution. From last year’s headline-grabbing partnership between US peer-to-peer (P2P) marketplace Lending Club and China’s e-commerce giant Alibaba, to The Credit Junction’s own alliance with the Houston Minority Supplier Developer Council, these initiatives ultimately provide a range of alternatives for SMEs to evaluate and pursue.
Invoice factoring/vendor financing:
These companies also use technology, but for a very specific purpose – to help small businesses overcome their short-term cash flow challenges. Whether it be buying unpaid invoices or advancing against accounts payable (APs), they leverage data analytics and platform technologies to provide fast access to near-term cash. These alternative lenders typically lend less than $250k (with $25k on average) and funds can be available within one to three days.
Today, the alternative lending ecosystem continues to grow, creating a new and innovative lending landscape that is sure to evolve for years to come. Every facet of the traditional banking paradigm is under attack from technology based disruptors. And with JP Morgan’s recent announcement of a strategic alliance with online lender On Deck Capital, the collaboration has just begun. Taken together, the resulting benefit over the next one, five and 25 years to American consumers and US businesses of all sizes will be dramatic and transformative in ways we can, and cannot yet, envision.