Three considerations for bankers to enhance SMB lending

It’s no secret that small and midsize businesses (SMBs) fuel the economy. The Chamber of Commerce reports that 99% of the businesses in the U.S. are small businesses—that’s roughly 33.2 million small businesses. However, SMBs continue to face adversities from the residual effects of the pandemic, rising inflation, labor shortages and ongoing general economic recessionary concerns. 

With reports showing that 38% of small businesses fail due to lack of capital, here are three considerations for bankers to better understand SMB lending preferences: 

How CDFIs can drive SMB lending in their communities 

In April of this year, the U.S. Treasury awarded over $1.73 billion to 604 registered Community Development Financial Institutions (CDFIs) through the CDFI Equitable Recovery Program (ERP). This represents the largest CDFI grant program in history, empowering community FIs to help develop long-term wealth in low- and moderate-income communities by growing their lending, grant-making and investment activities. 

CDFIs are uniquely positioned to promote growth in economically challenged communities through a range of programs. For small businesses within these communities, the ERP grant is an effective avenue for funding, as it provides much-needed capital that may not be otherwise available. 

In recent years, fintech companies have pioneered modern Lending-as-a-Service (LaaS) technology to streamline loan application processes for SMB applicants. This innovation has spurred traditional community banks and credit unions to adapt and modernize their lending strategies. By implementing LaaS strategies, community FIs can optimize their lending processes, making them more transparent and efficient for customers. 

FIs that harness data successfully, either from their own sources or through external networks, can make more informed decisions and build healthier loan portfolios. For CDFIs, intelligent automation of origination and underwriting allows them to establish an SMB lending program that is both efficient and cost-effective. They can then swiftly deploy ERP funds to small businesses while ensuring compliance with CDFI program requirements and banking regulations. 

State-level SMB disclosure requirements and how to prepare 

California, Utah and New York City have recently enacted commercial financing disclosure laws this year, with Georgia and Florida expected to follow suit by January 2024 and Connecticut by midyear. The purpose of these laws is to empower small business owners to better understand the costs and benefits of commercial financing while also facilitating comparisons among different offers, helping SMBs find the most suitable financing solutions.   

Business lenders and commercial financing companies will need the ability to produce compliant disclosure statements that meet each state’s requirements as part of the application process. This can include tools to help simplify the complexity of APR calculations and options to create required disclosures in HTML for webpage review and PDF-printable formats.  

Recognizing the potential friction that these new compliance requirements may introduce, small business finance companies should proactively adopt the necessary tools and procedures to meet the financing needs of their clients. 

What small business owners look for when selecting a lender  

When making business loans, lenders primarily seek established businesses with a track record of profitability and predictable cash flow to ensure timely loan repayment. Additionally, lenders consider factors that enhance the security of the loan, including the creditworthiness of both the business and its owners. Past debt repayment behavior can be a strong indicator of future performance. 

Lenders also pay close attention to the purchaser’s industry experience to gauge their ability to run a profitable business. Since new businesses often struggle to secure loans, they frequently rely on equity investments from other owners, family or friends. Demonstrating “skin in the game” through owner investments is crucial to showing commitment and willingness to bear the initial losses if the business faces financial challenges. 

However, there are strategies that new businesses can employ to reduce upfront investment requirements. These include securing customer retainers, requesting down payments and progress payments and negotiating extended payment terms with suppliers to lower businesses’ working capital needs.  

Ultimately, the timing for seeking small business capital should be driven less by market conditions and more by specific business opportunities. Taking full advantage of these opportunities in a quickly changing market requires speed and agility. While prudent risk assessment and financial cost-benefit analysis are vital for making sound financial decisions, business owners should not be deterred by inflation-driven borrowing costs. If a compelling market opportunity arises, savvy business owners should be prepared to capitalize on it. 

By leveraging CDFI grants, preparing for state-level disclosure requirements and understanding the criteria small business owners use to select a lender, bankers can play a pivotal role in supporting the growth and resilience of SMBs while helping to ensure they receive the financial support they need to thrive in a challenging economic landscape.  

Will Tumulty is CEO of Rapid Finance, a market-leading fintech company helping small businesses find sustainable and customized financing solutions through a fast and simple application process, and one of the largest providers of working capital to small businesses in the U.S.