Traditional Credit Assessment in Raising Money
Raising money is a daunting task to small business borrowers. Most lenders depend on traditional credit information sources and analytics such as obtaining an entrepreneur’s credit score. Providers of credit such as banks, credit card companies, depend on credit scores to assess the prospective risk posed by the potential borrowers.
For the small business borrower raising money, many entrepreneurs feel that they are at a disadvantage. In an empirical study by Allen N. Berger, Adrian M. Cowan, and W. Scott Frame (2011) found the use of consumer credit scores rather than business credit scores by community banks in small business lending when the banks underwrote small business credits. Community banks often used the scoring for only very small loans typically under $50,000. The study suggests that community banks depended more relationship lending than the using of technology when utilized credit scores for automatic approval/rejection of loan applicants.
In the U.S. the most widely used statistical credit score model is the FICO score initially developed in 1956 by Bill Fair and Earl Isaac and sold by the FICO Company. The FICO Score model is designed to measure the risk of default by taking into account numerous factors in a person’s financial history such as payment record, the utilization of credit, length of credit history, the type of credit used, and other proprietary metrics.
Currently there is an emergence of companies chasing small-business loans by using alternative data sourcing then consumer credit scores to extend credit. These companies include Capital Assess Network, Kabbage, and Amazon
Kabbage leverages social media data as part of lending decisions. The company grants working capital to online merchants as its credit risk model encompasses social media and loyalty assessments in an effort to attract, interact with, and retain small business clientele.
The Atlanta base company founded in September 2011, Kabbage connects with clients Facebook fan pages and twitter feeds. According to the Credit Union Times (Samaad, 2012), Facebook and Twitter feeds are immediately analyzed and translated into capital. With merchants increasing the number of followers, the enhanced activities and chatter on Facebook and Twitter increases the amount of capital access. Known a Social Klimbing, the merchant cash advance is called a “Kabbage Advance.”
The advance is not a loan. No interest charge is assessed. A fee is charged base on how long the advance is outstanding. No prepayment is assessed for early payments. Advances range from one to six months. The company founded a correlation between the activity on social media and default rates. Merchant cans obtain advances as low as $500 up to $100,000.
Last year in May, Bank Technology News awarded Kabbage’s CEO Rob Frohwein for conceptualizing its breakthrough technology and data platform that provides working capital to small business in less than seven minutes. In winning the Top 10 Innovator award, Frohwein was recognized for its significant impact on small business (PR Newswire, 2012).
Kabbage received venture funding by Mohr Davidow Ventures and BlueRun Ventures. Additional investors include David Bonderman, founder of TPG Capital, Warren Stephens, CEO of Stephens Inc., the UPS Strategic Enterprise Fund, and TriplePoint Ventures.
Capital Access Network, Inc.
Capital Access Network, Inc. (CAN) is becoming a significant player in providing small business credit scoring and capital. The company developed a technology platform that automatically analyzes a multitude of business performance variables that integrate data sources from banking, credit card processing data and other sources with its proprietary risk models assessing over 100,000 transactions over multiple business cycles reviewing over 650 SIC codes. Its model is considered an alternative to the FICO score. Over $2.5 billion in working capital financing were granted to small businesses since 1998 through NewLogic Business Loans, Inc. and AdvanceMe, Inc., both CAN subsidiaries.
Determining the strength of a business based on business performance rather than personal credit scores and the ability to provide access to capital has given CAN a leg up on other small business lenders. WebBank, a Utah-chartered FDIC industrial bank underwrites the loans for NewLogic Business Loans Inc. and AdvanceMe, Inc.
Headquartered New York headquarters, Capital Assess Network has presence in Boston, Atlanta and San Jose, including Costa Rica. The company employs approximately 400 people with the majority focused on data services technology and analytics.
Other Alternative Lenders in Raising Money
The companies using alternate means to assess credit risk to provide financing for small businesses include ZestCash, BillFloat and LendingClub.
Berger, A. N., Cowan, A. M., & Frame, w. S. (2011, August 1). The Surprising Use of Credit Scoring in Small Business Lending by Community Banks and the Attendant Effects on Credit Availability, Risk, and Profitability. Journal of Financial Services Research , 1-17.
PR Newswire. (2012). Kabbage CEO Selected as a Top Innovator by Bank Technology News . Atlanta: PR Newwire.
Samaad, M. A. (2012, June 27). Kabbage Links Social Media With Cash Advances. Credit Union Times, p. 15.