Vantage Point


Generational trends and automation shaping small-business lending

By Michael Stefanick

In a post-recession, highly-regulated financial environment, small businesses continue to fuel the U.S. economy, but make no mistake: A lot is changing in this dynamic sector. Factors such as the housing rebound, credit preferences, alternative funding schemes and aging workforce demographics are driving important shifts in small-business financing.

While small-business lending has lagged behind other loan markets since the end of the recession, pent up demand, easing of lending restrictions and increases in household wealth should serve as catalysts for a turnaround. Indeed, recent data shows that the small-business lending market is at an inflection point such that growth should accelerate in 2014. 

Though small-business loan balances declined 15.2 percent from a peak in 2008, that contraction began to reverse in 2012 for small-business origination loan amounts greater than $100,000, and in 2013 for loan amounts less than $100,000. Overall, small-business loan balances increased 3.1 percent year-over-year in the second quarter of 2013. 

Recent loan growth has been particularly robust in microloans—those less than $100,000—which has paralleled the rise and fall of the housing market. Microloan balances at all banks increased 30.8 percent between 2005 and 2008, but then reversed considerably through 2012. Balances once again reached into positive territory in the first quarter of 2013 with a year-over-year gain of 2.3 percent.

Similarly, small-business credit demand has lagged during the economic recovery, but is now finding firmer footing. It is being driven, in part, by improving household wealth.

Small businesses often tap home equity to expand or invest in their businesses to varying degrees, especially in times of rising real estate values. Home equity line originations in 2012 increased by more than 6 percent to 870,000 from the prior year, albeit prime risk-focused. This is the first annual increase in five years.

Alternative lending

Perhaps the most notable trend in small-business lending is the emergence of alternative financing sources such as equity crowdfunding—selling ownership stakes in a company by soliciting investors via the Internet—and microlending, which are quickly gaining traction. While commercial lenders are slowly easing credit restrictions, many entrepreneurs and small-business owners are seeking faster, easier alternatives to the strict and often burdensome process of securing funds.

Alternative microloan lenders pose the greater near-term threat to traditional institutions as they have the advantage of leveraging automated platforms to reduce friction in the lending process. They can largely eliminate the traditional, lengthy application process and onerous data collection, elaborate underwriting reviews and multi-step credit approvals.

Crowdfunding in the small-business market is growing in the United States, but it is still somewhat undeveloped and much of what exists today is boutique in nature. Regulatory issues must be settled before it can become a bigger factor. The Jumpstart Our Business Startups (JOBS) Act does support the growth of U.S. equity crowdfunding in principle, but the Securities and Exchange Commission has yet to finalize rules that would allow the practice to happen on a wider scale. However, the SEC looks to now be working on an equity crowdfunding proposal that could open this type of start-up investing to non-accredited investors in 2014.

As these alternative lending sources evolve, they will become viable options for a new generation of small-business owners: baby boomers. Just as baby boomers are predicted to have a large impact on entitlement programs, so too are they poised to be a primary driver of small-business formation in the next decade and beyond. While small-business formation has been flat, remaining below pre-recession levels, both demographic trends and recent surveys point to boomers having a positive, sizable impact on the number of new businesses formed.

Although the oldest of the generation began reaching retirement age in 2011, many are extending their time in the workforce to earn supplemental retirement income to compensate for the detrimental impact the recession had on their investment portfolios. As baby boomers choose to work past 65, they are more likely to start a business than their younger counterparts. Data from the U.S. Bureau of Labor Statistics show that the likelihood of being self-employed increases with age. More than a quarter of those self-employed in the United States are 65 and older, much higher than any other age category.

As boomers become more inclined to start a small business, they likely will be much better able to secure lending from financial institutions. Boomers represent a much safer credit risk than younger generations and are the ideal candidates for starting small and medium-size businesses. They tend to have business experience, an established network of contacts, a proven financial and credit history, existing startup capital (savings) and a lack of debt.

As such, small-business lenders would be wise to segment and tailor offerings to the boomer generation that reduce the friction during the loan experience. Modernizing and streamlining the lending process by marrying finance, alternative data sources, analytics and technology not only would help capture emerging boomer business owners, but younger demographics as well.

Automation advantage

Key to eliminating this friction is automation. A comprehensive loan automation system can shorten the approval process by reducing the need to manually submit and input financial, tax and other loan information needed for approval, while automating decisioning and improving loan tracking and reporting capabilities.

Imagine the delight of small-business owners when they learn they don’t have to fill out by hand multiple forms asking for the same information. Loan officers will benefit from having more time to spend building customer and community relationships. A more efficient evaluation process will help ensure the credit department can keep up with any influx of new business loan signings without sacrificing rigorous due process or incurring any additional risk.

In addition, systems with advanced analytics can help harness the abundance of “Big Data” available and apply new credit risk tools to help connect the dots among consumers, small businesses and broader market trends. They also can provide predictive scores that forecast the likelihood of a business failing or defaulting on a payment within the year. This will give lenders a more complete and comprehensive picture of the small business and the business owner, and better insight into the financial competence of a business and its stakeholders.

Identifying linkages between portfolios also can provide lenders with more marketing opportunities by identifying which of their retail customers also own businesses. Equifax data analysis shows that as much as 20 percent of consumer accounts in a portfolio may be comprised of small-business owners or principals.

In sum, automation not only will eliminate a multitude of administrative and billing complexities, it can provide stronger, more consistent risk assessment and an improved customer-focused lending experience just when demand is returning to the small-business lending market.

Michael Stefanick ( is senior vice president, commercial analytical services with Equifax Inc., a credit reporting agency in Atlanta.