Clean up your books, print your income statement and bank statements, Xerox your incorporation documents. Come down to the office at 1pm this Wednesday. There’s a lot across the street - we’ll validate your parking.
Twenty years ago, most business loans were underwritten by local banks and credit unions. The process was laden with paper documentation and subjective judgement by loan officers.
Two trends have dramatically shifted this process over the past 20 years:
- The Great Financial Crisis created an opening in the market for new lenders when they de-risked and slowed or stopped lending to small businesses; and
- Technology has streamlined much of the application process and loan officer judgment is being replaced by algorithms (no more parking validation!).
Despite the vastly different process, the core questions lenders are trying to answer remain the same.
1/ Is this application fraudulent?
Are you who you say you are? And is “who you say you are” a fraudster?
A loan application usually requires the applicant to type in some key information about the business and upload certain documents. This may include data elements such as who the owners are, where the business is located, and incorporation documents.
Lenders need to verify that the information that’s being provided is true. For the most part, this involves two steps:
- Checking the information provided by the borrower with third party sources (e.g. Secretary of State registration filings)
- Doing a background check on the owners
2/ Do we want to associate with this business?
Are you shady?
If an application seems valid, there is a more nuanced decision to be made by the lender - is this business one which has any reputational risk for the lending business?
Better understanding the borrower’s operations is required here. Some key elements that a lender may want to have a handle on include:
- Which industry the business operates in
- Which geographies the business operates in (Sanctions / OFAC)
- Who the business’ customers are
Checking third party sources for negative news or affiliation on the owners is often involved here, too:
- Politically Exposed Persons lists (PEP)
- Active litigation
- Other public records (e.g. news)
3/ What is the business’ track record for paying their obligations?
How have you treated business partners in the past?
The business’ propensity to pay remains critical. That is, assuming the money exists, how likely is the business to pay their debts/vendors?
Historical payment data on both the business and the business owners are often relied upon for this. Traditional credit reports will include data elements such as:
- Vendor reports on a business’ invoice fulfillment history
- Bank reports on a business’ loan repayment history
- Credit outstanding and drawn by individuals
Business credit data is notoriously incomplete, causing lenders to rely on pulling multiple reports from different bureaus and, ultimately, more heavily weighting personal credit reports.
4/ Does the business have the ability to repay their obligations?
Do you have strong enough business fundamentals?
Evaluating financial health is paramount for answering this question, particularly for unsecured loans. The crux of this analysis is typically cash flow analysis, with three primary steps:
- Rationalize the business’ historical cash flow
- Project the business’ cash flow into the future (duration-matched to the loan product)
- Monitor the business’ cash position through time to adjust risk profile
1/ Historical cash flows are generally collected from either
- Financial statements prepared manually by the business; or
- Bank statement PDFs; or
- Bank data aggregators (consumer-focused).
2/ That history is used as the basis for projection, which is a proprietary element of lenders’ underwriting models.
3/ Ongoing monitoring is attempted by requesting updated data from businesses, but is often foregone for long periods of time because
- Financial statements are often only updated once per year - during tax season
- Operators are slow to upload bank statements if it doesn’t immediately benefit them
- Bank data aggregators do not stay connected to business accounts reliably
Conclusion
The primary questions that business lenders need to answer remain constant, despite rapidly evolving underlying technology. At Basis, we’re focused on helping businesses’ represent their ability to repay their obligations. We’re building Cash Flow Profiles for lenders with:
- Stable connections to business-focused banks
- Analytics to rationalize historical cash flows
- Tools to power cash flow projections for lenders
Lenders should focus on lending - we’ll wrangle the data.
Get in touch if you think what we’re building could help your product or check out our jobs if you want to help us power better business lending!