Accessible funding for small and medium-sized businesses (SMEs) is a global issue, which means there’s plenty we can learn from our foreign counterparts who, like many of us in Canada, are spearheading innovative solutions.
Codat, for example, is a software company working with fintechs and financial institutions around the world (in fact, their technology enables Caary’s accounting integrations). From research reports to government advocacy, Codat is on a mission to understand barriers to funding and champion the potential of alternative lenders and open banking.
We interviewed Gabby MacSweeney, Head of Communications at Codat about their fascinating new report – Closing the small business funding gap – which explores reasons for the small business funding gap in the UK and strategies to narrow that gap.
The first thing we learn from your report is that the Bank of England estimates a funding gap for SMEs of 22 billion pounds. That’s significant! Why do you think this is the case?
First of all, what does the funding gap mean? It is the difference between the amount of external capital that small businesses have access to and the amount of capital that they need to continue to operate effectively or to grow.
The funding gap is really made up of two strands. First, businesses that need finance and apply but aren’t approved. And second, businesses who could do with external funding but decide not to apply – for example, because they’re put off by the process or they just don’t believe that they’ll be successful.
Interestingly, the group that isn’t applying for finance accounts for most of the funding gap.
Why do you think businesses that need credit aren’t applying for it?
In our research, we found that 73% of businesses in the market for credit had a negative perception of the credit market.
The biggest hurdle mentioned was that it’s expensive. Very close behind were how complex it is to apply and how difficult it is to get approved. So, we have real evidence that it’s actually the process of applying for finance that is one of the biggest perceived issues.
What does your research tell us about businesses that do apply for credit but don’t get it?
On the other side of the coin, about 25% of people who apply for SME finance are rejected. That number should never be zero, that’s not the goal. But that number is higher than it was pre-pandemic.
We found that businesses overwhelmingly go straight to their main bank when applying for funding – unlike consumers, who are a bit more likely to shop around for credit cards. But those large financial institutions tend to have the highest bar for approval. After going through what can be a frustrating application process, businesses might not have the confidence or time to invest in another application.
That can be the end of the road for them.
Codat and many fintechs in the UK suggest that the SME Funding Passport could help close the funding gap. For our Canadian audience, what’s a funding passport and how would it work?
Essentially, it’s a digital file containing the core data that’s needed to underwrite a business. The idea is that we’ll go beyond open banking to include not just digital bank statements but also financial statements, and that data will be available in a standardized format.
We think this will accomplish a few key things. First, it will improve and shorten the application process for small businesses if they can share their data digitally. And the standardized format means it will be easier to share that data with more than one lender. It won’t be as painful or time consuming if they’re rejected by the first provider.
The SME Passport will also make it much easier for lenders to look at live data for underwriting. They’ll have access to better customer data for underwriting, which in turn could make the lending process more efficient.
Your research finds that 37% of potential borrowers have heard of alternative lenders, and 18% of those borrowers trust new online-only lenders. This is compared to 58% who trust their high street bank. What do you think it will take to build more trust in alternative lenders?
Banks have been around for hundreds of years, so it’s no surprise that the level of trust is much higher than it is for alternative lenders. It wouldn’t be fair to expect, or even aim for, that same level of trust. And although 18% seems low, it’s actually higher than for some other big institutions – for example, the media.
What we found is that trust is very much linked to awareness. When we cut the data down and looked at small sole traders who had lower awareness of alternative lenders, they were much more skeptical. Increasing awareness of the alternative lending sector will certainly help, whether that’s with help from the government or campaigns from individual providers or even a joint awareness campaign.
We also looked at the impact of regulation and trust marks in terms of building trust. Many B2B lenders are regulated here in the UK and in many other places, but some aren’t, and some types of lending aren’t. When we asked small businesses if they’d be willing to share data with a company that the government endorsed, the percentage of people who said no dropped by 13 percentage points. That does suggest that government trust marks do have an impact on the level of trust.
Who do you think is responsible for building that awareness and trust – the government or alternative lenders?
I think ultimately it comes down to who is the most motivated to do it. In many ways, lenders always have motivation to build that trust, so I think working together as an industry is key. But lenders could make the case to the government that, particularly when it comes to SMEs, this is the sector that we’re banking on to get us out of this recession, these are the people who contribute more than 50% of the GDP. If you can stimulate this sector, you’re driving economic growth. And to stimulate the sector, you need to help financial providers. I think there’s plenty of space for government support, and I think it could be really impactful.
In Caary’s research, we found that 54% of Canadian SMEs would consider a provider that used open banking if it meant easier access to corporate credit, and nearly half (47%) would exchange more of their data for better access to superior financial products and services. In comparison, your report found that 90% of SMEs with more than 10 employees would be willing to share their data for better rates and products. Why do you think that willingness is higher in the UK?
One thing to note is that we were asking about sharing your data with any kind of financial service provider, we weren’t specifically looking at alternative lenders. But I think the critical thing is how you present the value exchange.
According to our research, the biggest issue with the current system in the UK is the cost of finance. So, when we specifically say, “if you could get a better rate – let’s say one that would save you $1000 over two years – would you share data from a few monthly management accounts?” That’s a question that people are much more likely to say yes to, even more so than asking if they’d exchange data for better services. So how you present the benefit is really important.
This is also true for the lenders we work with – the wording they use when asking for consent to access data matters. We’ve done research with our own lender clients to see what increases conversion when asking small businesses for access to data, and so much of it comes down to how you articulate the value of sharing that data.
Your report highlights open finance as an important next step. I understand that open finance builds on open banking by enabling access to a wider scope of financial data. We’re a bit behind the UK in Canada – we’re still working to establish an official open banking regime here. How does Codat see open finance helping the small business community?
I would say that yes, Canada is behind the UK when it comes to legislation but not necessarily in terms of adoption. I’ve read that four million Canadians are already accessing budgeting or account aggregation tools via screen scraping in the absence of APIs.
But we are further ahead in the UK. We’ve almost completed the open banking roadmap that was set out in 2016. And with all talk turning to finance, we’re seeing very early conversations about open finance.
What we’re really passionate about at Codat is open finance for small businesses. What we mean by that is enabling access to other sources of financial data that small businesses have, the main ones being accounting systems and ecommerce systems. We would advocate for legislation similar to open banking that reduces red tape and restrictions for accessing that data for certain use cases.
At Codat, we’ve had several meetings with the government in the UK who are relatively receptive to the idea, which is fantastic. And we’ve brought together a panel of SME lenders to help us advocate for the concept. So keep your eyes peeled for more!
Gabby MacSweeney, Head of Communications at Codat