[Editor’s note: This is a guest post from BJ Lackland, CEO of Lighter Capital. Lighter Capital is a bronze sponsor and will be in attendance at LendIt USA 2015 on April 13-15. In this post, he talks about three principles for moving online lending to capital-as-a-service for small business.]
There is no doubt that cloud-based technology has streamlined the borrowing process and is leading to the rapid democratization of capital for small business. The proliferation of funding alternatives for entrepreneurs and the ability to access it rapidly is, generally speaking, a good thing for business and the economy.
However, just because something is getting easy doesn’t mean it is good and it is time to make sure that online lending is not just good for lenders but good for long-term business growth. We as an industry need to ask ourselves: Is the ability to access funding in a matter of minutes as important as making sure the business owner knows the true cost and consequences of taking on more debt? Isn’t it likely to be more beneficial in the long term to use technology to make better investment decisions not just faster ones? Because in the end, is it not better for everybody that the funding we provide online promotes, not inhibits, healthy business growth?
In the way that the software industry evolved to a more user friendly Software-as-a-Service model, for small business customers, we think its time for online lending to do the same. What we call – Capital-as-a-Service. Here are three principles that we at Lighter Capital believe are critical to creating a thriving Capital-as-a-Service industry. One that is sustainable for lenders and the entrepreneurs they serve.
Principle #1: Lend for long-term business growth
Small business can access capital relatively easily, from credit cards to merchant cash advances – if they are happy to do two things. First, put their personals assets up as collateral and; second, agree to fast repayment terms generally starting the day after the loan is made. When you can’t pay a vendor or your employees because you’re waiting for a customer to pay you, it can make sense to take out this kind of emergency funding – but the fact is – it doesn’t help the entrepreneur succeed long term.
It’s surprisingly harder for growing small businesses that are actually in good shape to find capital as compared to those looking to get bailed out of a sticky situation. Banks often won’t lend to companies without significant track records and physical assets, while equity investors are looking for a very few breakout investments. The online lending community is, as we said, focused on lending small amounts, fast, for short periods at high interest.
So there is a gaping funding gap for small business that wants true growth capital. The way to fix it is by providing long-term growth funding that is less one-size-fits-all and more industry and/or stage specific. Lighter Capital, for example, currently solves the specific funding needs of early stage technology companies. They have great margins and predictable revenues but not physical assets. So we created a debt structure tailored to their business characteristics – a five-year revenue-sharing agreement that is tied to their revenue and growth while blending the best of equity and debt.
Online lenders can easily provide fast cash, but at what cost? A sustainable industry is one in which the interests of the lender and borrower are aligned, one in which the lender succeeds when the borrower’s business grows. We think this approach would lead to both lower default rates and interest costs while providing entrepreneurs with substantial growth capital that’s still cheaper, more accessible and provided faster than any venture capital firm or bank can do.
Principle #2: Use technology to improve, not shortcut credit analysis
If the goal is to make a fast lending decision, using an entrepreneur’s FICO score is an obvious way to go. Problem is, the personal creditworthiness of an entrepreneur doesn’t really reflect the likelihood of future success for his or her company.
In this era of big data and machine learning, with corporate data residing in the cloud and flowing seamlessly from application to application, its time to take a more sophisticated approach to underwriting and credit analysis. Lets not use technology just to make the process faster – let’s use it to make it better as well.
At Lighter Capital, we do this by hooking into multiple sources of information. These include social channels (LinkedIn, etc), accounting tools (e.g. QuickBooks), bank accounts and CRM platforms such as Salesforce.com. With a more rounded view of our borrowers financial and market positions we can rapidly structure and fund a loan based on a detailed credit analysis and understanding of our customer’s business.
Consequently, we are learning a great deal more about our borrowers and what characteristics are tied to different performance structures. This can only help to build out our credit model and enhance the services and loans we will be able to offer through our online underwriting and servicing platform. This, we are sure, will lead to even more tailored loans that better match borrower needs and outlooks to our investment requirements – lowering both parties risk of default. It’s a model we think is repeatable across a wide range of industries.
Principle #3: Be entrepreneur-centric
It’s doubtful that we will ever return to the days when community bankers lent you money because they knew you and your reputation. However, with all of the information that is available to lender’s out there, the reversion to the mean of using personal credit scores to instantaneously provide loans feels like we are going backwards instead of forwards.
We believe it’s better to think like a long term investor. Get to know more about the industry an entrepreneur’s company is serving, what their product is, and who their customer base is. Understand what makes their business tick and what funding and growth problems they are trying to solve.
The advantage of being an online lender is that you can leverage technology to speed up the process of collecting, transferring and analyzing data. So rather than focusing on speed alone its imperative to focus on collecting as much information as possible in order to make better investment decisions.
But don’t stop there, use technology to communicate, educate and build trust with small business owners. Funding decisions are not small things to entrepreneurs. Taking a little more time to learn more and also make sure the borrower really understands what it is they are committing to can only be positive for a long term relationship. Even by taking a bit more time to do all this it’s still pretty likely the entire funding process will still be much faster and more efficient than that of a traditional bank or venture capitalist.
Its time to take the best of what technology can offer and create a better a funding model that truly meets the needs of small business and sets entrepreneurs up for long term success. You know – Capital-as-a-Service.
I’m excited to be participating in the panel Small Business Lending Innovators, (10:05-10:35am ET, April 14th in the Astor Ballroom) or come by and meet the Lighter Capital team at booth 608 on the exhibition floor.