Small businesses in Canada contribute significantly to employment and gross domestic product. To succeed, many of them need fast access to credit, on terms that enable growth, as they progress from start-up to maturity. Yet, so far, small businesses have been an underserved credit market.
Pam Dodaro, Executive Director of Business Solutions at TransUnion, explores why and gives guidance on how lenders can improve this important segment of their portfolios.
Small businesses, big contribution to the economy
According to Key Small Business Statistics reports by Innovation, Science and Economic Development Canada, small businesses in Canada are making an increasingly significant contribution to the economy: in 2013, small business exports had grown by 56% from 2009, making up 25% ($106 billion) of Canadian exports ($420 billion in total).
This sector is also vital to employment in the country. The report states the number of people employed by small businesses in the Canadian private sector grew from 48% in 2011 to 70.5% in 2015. That’s an increase of 64% in five years. Even more significant is the 87.7% growth in net employment change between 2005 and 2015: in this period, over 1 million jobs were created by small businesses.
The contribution small businesses make to employment in Canada:
Small business credit: from underserved to well deserved
Smart lending to small businesses has significant benefits across the board: when small businesses succeed, more people are employed, which expands the consumer credit base. The economy grows, which means even more opportunities, and less risk, to lenders. By providing small businesses with easier access to credit, lenders can help to accelerate this growth. This in turn generates significant payoffs for all: credit providers, business owners, employees, and the economy.
Yet, despite these opportunities to lenders, when it comes to credit, the small business market is largely underserved—mainly because it’s been difficult to access and operationalize relevant data points.
Getting small businesses on board, on the right terms
Credit providers need access to various data sources to assess risk and comply with regulations – which can be a cumbersome, time-consuming task. This has resulted in slow and inefficient processes that frustrated both the lender and the small business owner.
This information is available, but fragmented and multiple data sources make it hard to digest, and the depth of data is scant. This results in a long and involved credit application process. Lenders have to go through manual, time-consuming procedures to assess risk—visiting the business location, understanding the articles of incorporation, and so on. This slows down the process of getting credit to businesses, often at a time when businesses really need the funding. They may therefore turn to personal credit or other, more expensive solutions, to fund their enterprises—particularly in the start-up stages.
Until recently, the small business lending environment has been the least automated, with the longest application process. Credit providers have had to search for information and have not had access to the kind of tools and products available for assessing consumer credit risk. By reducing the time it takes to assess creditworthiness and process applications, they will be able to onboard customers and extend credit more quickly.
Data that tells the full story
With small business funding being more of an art than a science, it’s easy to see why lenders defaulted to using consumer debt as a proxy for this data. As most small businesses had no credit footprint in the first few years of operating, which is when small business risk is generally highest, lenders relied on the business owner’s consumer credit history when evaluating applications and assessing risk.
But this approach doesn’t tell the full story, resulting in blind spots for the lender. A TransUnion analysis showed that while consumer credit performance may be highly predictive for business credit, over 90% of businesses remain current even if consumer credit is impaired. If you are a credit lender trying to assess the financial strength of a business, you need to look beyond consumer data.
To illustrate this, let’s say I start a small catering business from home, called Pam’s Pizza. It’s a registered business that’s initially funded by my personal savings and credit card. As my reputation grows and orders increase, I’m able to negotiate good terms with my suppliers. They give Pam’s Pizza a 90-day credit facility, and I always pay in full, on time. When it’s time to move to a small storefront, I approach my bank for a loan so I can increase my store of supplies and get financing to buy a delivery bike. But because my business is still growing, all the bank considers is my personal credit history: depleted savings and maxed-out credit cards. I’m seen as a high risk, and so is my business. What they don’t see is Pam’s Pizza’s operating line with suppliers, which would tell a different story.
A credit footprint for small businesses
Now that new data and analytics are available, there’s no need to rely solely on personal credit data as a proxy when a small business applies for credit. Rather, lenders should leverage all available data, on both the business and its owner, to improve risk decisions at each stage of the business lifecycle.
In creating a credit footprint for small businesses, TransUnion has incorporated traditional bureau data with alternative data to help lenders get insight into how the business manages its credit facilities. This provides a holistic view of the business and assists in addressing these potential blind spots.
The data we look at includes:
- Consumer bureau data: the credit performance of the owners
- Business bureau data: business credit performance
- Supplier data: Trade supplier payment performance
- Public record data: any liens, bankruptcies or judgments
- Firmographic data: corporate profile and ownership structure
With insights into the credit footprint of a small business, lenders will be in a better position to provide credit facilities to the right customers, at the right time. And with easier access to larger credit facilities, at good rates, small businesses will be able to grow, which benefits everyone.