Narratives Versus Credit Scores
In conversations with small business lenders, it’s common to hear statements about there being “plenty of money to lend, but a lack of qualified borrowers.” With access to capital being a top issue for small business owners nationwide, there’s certainly no lack of demand. Businesses that would not only service debt if the opportunity were extended, but that would also grow and expand, boosting their local economies as they thrive. One reason for this gap between companies that would benefit from debt capital, and lenders in search of viable opportunities to put their capital to work, is the method of data collection. If businesses who are able to repay are not able to qualify, however, then the issue in lending is not simply a lack of qualified borrowers to lend to.
Many of the commercial loan products on the market today are not designed with the hustle of small business owners in mind. Ones that are – primarily online lenders – rely heavily on high-interest rates to provide fast loans based on little information. Large teams and formalized business processes within larger companies make it far easier to provide the numerical data (such as well polished financials) that most lenders desire. While larger teams and more formal financial reporting is the long-term goal of small business owners, we’ve discovered that the short-term challenge of collecting useful underwriting data from small business owners can be overcome by narrative-based collection methods. A storytelling approach that yields far more than financial data alone. For our Growth Loan, we deploy a number of strategies to glean such data, including a Q&A style survey with questions that committee members are likely to ask.
Narrative based solutions for an informal industry
When it comes to risk, we’re still interested in the time-tested factors, but we’re even more interested in the “why” behind them. When reviewing forecasted financials, there are always questions. Why do you expect your revenue to increase? Why are you paying so much for a lease? Are you sure your costs of goods sold are accurate?
There’s an aspect of informality when it comes to small business financials that make it more practical to gather information conversationally than through a rigid framework based on a lender down design. While the long-term goal for any business is effective financial reporting, it’s not uncommon for a small business owner to manage their business more instinctively at first, and then formalize more of their internal processes as revenue grows. In fact, there is probably a good reason for building the business in this way, as extreme flexibility and adaptability are demanded of just about all entrepreneurs during the early stages of their business formation. While a Growth Loan applicant will ultimately have to provide some version of forecasted financials, that comes at a later point in the process.
We have learned that a question and answering process through a survey tool actually provides valuable data beyond a financial snapshot. Insight into leadership qualities, reputation and problem solving are naturally discerned through answers to questions which demand more than a yes or a no. More than a binary response. How invested is the entrepreneur in the success of the business? What is their big hairy audacious goal for five years down the road? Why did they decide to start the business in the first place? These are all questions that a loan committee is not typically able to ask, or might ask in a manner that only requires or even allows for simplistic responses.
The traditional financial review comes later in the process
We postpone heavier evaluation of numerical data, such as multi-year financial projections, until later in the review process. Placing this review at the end not only provides time for an applicant to collect their thoughts and create more useful financial data, it also allows the loan committee to observe and digest other factors that add context to financials. Most lenders expect borrowers to begin their application process with financial statements. We have found that upending this process also creates additional value for applicants who receive constructive feedback from a knowledgeable review committee throughout the application process.
To be clear, we do include questions that screen for risk based on financial data. We design these questions in a manner that draws out useful information in situations where hustle outweighs formality. Our goal is not to ignore traditional underwriting, but to innovate for the benefit of small business owners. One traditional limitation that has been difficult to overcome, even with the narrative method, is gaining underwriting confidence to lend more than $10,000 to a business without a year of history or revenue. So much is discovered within the first year of operation that a small business is highly likely to deviate from their original plan in finding their pathway to success. Investing too much capital too early could lock an entrepreneur into a strategy that they would be better off abandoning.
Our goal is not to ignore traditional underwriting, but to innovate for the benefit of small business owners.
Our entire approach is rooted in a desire to know the applicant and business in a way that is more accurate than their credit history. While there are cons to a higher-touch approach to underwriting, there are many benefits as well. For starters, there are more small businesses out there who are able to repay (qualified) which means lenders are leaving business on the table. Interacting with applicants in a way that is beyond the typical financial review is also inherently relational. Combine this relational approach with an opportunity that could not be found elsewhere, and the possibility for excellent repayment and repeat borrowers should increase.
Small business growth is too important to let the access to capital dilemma persist. We’ve encountered dozens of businesses who are successfully paying back small loans, who were unable to qualify in a traditional sense. And if you’re an organization that supports small business growth in a community that could benefit from our innovative approach to loan underwriting, we’d love to connect.