Credit Decision Engine - Small Business Loans

There are over 30 million small businesses in America and it is the backbone of our economic engine. Small businesses employ close to 70 million Americans and it’s driving every bit of our economy across the board.

Banks and especially commercial banks are focusing on delivering banking services and loans to these small businesses to help them grow and therefore help the overall economy to grow. The US government through the Small Business Administration also delivers critical bank and financial services to small and medium businesses to grow.

During COVID, the US government offered PPP (Paycheck Protection Plan) to help small businesses to stay afloat, especially those small businesses that experienced an economic downturn but chose not to lay off any employees. Furthermore, the US government implemented further incentives such as the ERC (Employee Retention Credit) to further help small businesses to stay afloat.

Credit Decision Engine - Small business identity verification or Know Your Business (KYB)

Small businesses records and its ownership is notoriously difficult to find and verify. There are a few small businesses identity bureaus such as Hoover that does a decent job of verifying small business and its owners. But smaller businesses and their ownership information is near impossible to find and banks and lenders have to rely on state government filings to fill in the gap. These tasks could be cumbersome and inaccurate. 

However, small business owners have a certain expectation that if their business is brand new, it might take banks and financial institutions to verify them and verify their financial needs.

There are other places where you can find small business information such as Thomson Reuters’ CLEAR and LexisNexis. Two of the major credit bureaus in the United States also have small business identity information. Both Equifax and Experian have commercial credit bureaus where it houses a certain amount of small business information.

For banks, credit unions and financial institutions to offer credit to small businesses, it must use a credit decision engine to ingest commercial or small business data. The journey doesn’t stop here, once a small business is found in these third party data bureaus, the lender has to verify the owners and their ownership of the business. 

It is important to also verify the owner’s identity and whether they, collectively, own more than a majority of the business. This has implications in that the person applying for credit has the authority to enter into a credit agreement with a bank or a licensed small business lender.

Credit Decision Engine - Small business cash flow analysis

Underwriting a small business for credit is extremely difficult but not impossible. First, you have to consider the seasonality of the business, the type of business and if possible, all of its income, expenses and liabilities. It isn’t as easy as offering a personal installment loan where all a lender needs to review is personal credit and person income.

A small business could make money from their sales but if the business is managed correctly, expenses and liabilities could outpace the amount of money cooking in and the business could be losing money. In any case, the bank and the lender will have to make a decision on whether the credit requested by the small business owner is to grow the business or used to plug their financial institution.

There are a few third party data providers which a credit decision engine can integrate to verify A/R or account receivable of a small business. Meaning that the data coming through these third parties can give the lender a preview of all the monies that’s coming in the next 30, 60 or 90 days. This will give banks and lenders some comfort that these small businesses will have the ability to repay their loan going forward with necessary revenue or income to service (or pay) their debt.

Cash flow analysis can also be conducted with third party analytics tools. These specialized vendors focus on cash flow (you can think of these as cash flow decision engines) that can take income, expenses, liabilities and analyze how much free cash a small business has to repay interest on a new line of credit or monthly debt obligation of an installment loan.     

If all else fails, the credit decision engine should be able to ask for documentation to be uploaded and parse the information within the uploaded document. There are third party vendors that can be integrated into a credit decision engine which scans through bank statements or tax returns and parses critical information from the uploaded files.

Credit Decision Engine - Small business ownership, licenses and certificates

When it comes to small businesses, these businesses must be licensed, bounded and in many situations, specialized certifications need to be obtained to conduct their businesses. Lack of business licenses, or certification of good standing might jeopardize the ongoing operations of a small business and therefore could shut down their revenue stream and lose their ability to service the debt on a newly minted line of credit or business installment loan.

Decision engines must integrate into databases such as LexisNexis, Hoover or CLEAR to see if the latest business filings are up to date with state and local government and agencies before making a final credit decision. For instance, if you are lending to a roofing company in California, the roofing company must hold a license for jobs over $500. Lenders might have to think twice before lending to roofing companies without a license or their license was recently revoked.

So, what about the small business owners themselves? Banks and lenders must also verify their identity which we covered earlier in a previous blog. Banks and lenders will need bring small business owners personal credit into the decision engine and weigh the combined information of their personal information and the small business's cash flow information and determine whether they want to extend credit to this small business.

Most of the time, sadly, small business owner’s personal credit is not that great. Mostly because they have been using their personal credit to start their business and perhaps most of their outstanding line of credit or personal credit card is already maxed out.

LendAPI’s credit decision engine

Small business lending is hard but it doesn't have to be harder with lack of technology and data integration. If you are in the space of small business lending or account receivable lending, we would love to hear from you. 

Check us out at www.lendapi.com or email us at info@lendapi.com. We would love to show you our credit decision engine and how we can help you to build your small business lending underwriting process.