Many lenders find it difficult to evaluate the credit risk of small businesses, particularly those with little or no credit history. To determine the right credit strategy for a small business throughout its lifecycle, lenders need to assess a wide range of data relating to the credit performance of the business, its relationship with suppliers, and the personal credit performance of its owners.
Abeer Waseem, Product Manager at TransUnion, explains how leveraging a risk score that uses trended credit data combined with business owner information can contribute to a more holistic view of — and better insight into — the health of a small business.
Challenges of getting the big picture on a small business
As noted in one of our earlier blogs, small businesses make a significant contribution to the economy but are largely underserved when it comes to credit. This is because it’s been difficult for small businesses to create a credit footprint that can provide lenders insight into how they manage their credit facilities.
The information is available but not exactly at the click of a button. Many lenders rely on a manual, cumbersome process to acquire data from different sources, and even then, there’s no guarantee they’ll cover all the bases. For example, the business may have a loan with another bank or credit from other sources the lender is unaware of. Then there’s the matter of linking and analyzing all this data to identify trends and determine how the business may perform on the loan.
Assessing businesses as businesses (not consumers)
Given the challenges lenders often face in assessing the creditworthiness of a small business, a common practice has been to use the business owner’s personal credit history to assess the risk of the business. And while there’s a strong correlation between the owner’s consumer risk and the business risk, the owner’s personal credit score is not a sufficient predictor of business risk and may result in missed opportunities for lenders and small businesses. In a TransUnion analysis of small business credit behaviour, 90% of businesses whose owners were delinquent on their personal accounts remained current on their business accounts.
There’s also the issue of managing the portfolio over time: Lenders need a clear view of how the business is performing as it matures, as it may be quite different from how the owner is performing as a consumer.
Assessing small businesses as businesses helps put lenders in a better position to differentiate, segment and manage their small business portfolio.
A need for a next-generation solution
As the number of small businesses continues to grow, finding streamlined ways to assess the health of a small business is becoming more important. Our Small Business Risk Score helps lenders gain insight into small business risk by using both the personal credit data of the business owner and the credit data of the business itself — payments, age of credit file, previous delinquency, and historical balances and utilization.
But, there appears to be a gap in the market for a solution that evaluates the risk of lending to a business based on the likelihood of business failure, poor credit performance on business trades (business credit performance), poor credit history of the business owner (personal credit performance), or the business’ relations with its suppliers. Lenders need a better lens into the health of the businesses they lend to.
A TransUnion analysis found that nearly twice as many businesses could be scored using a risk score leveraging alternative data compared to using traditional data only
Scoring more small businesses with greater confidence
A TransUnion analysis found that nearly twice as many businesses could be scored using a risk score that leveraged alternative data compared to one using traditional credit data only. Alternative data sources include firmographic data, supplier data, trended data and business owner information, which help provide lenders with a more holistic view of business risk and assist them to score a small business even if it has no credit history.
Improving credit decisions throughout the business lifecycle
Greater insight into both business and owner risk can help lenders better predict the likelihood of delinquency on a business account. An enhanced ability to differentiate small businesses in terms of credit risk can help improve customer segmentation, which can help lenders tailor approval rates, loan amounts and interest rates by segment.
As a small business grows, the factors influencing its credit health — its credit performance, relationship with suppliers, and the personal credit performance of its owners — are likely to change. More effective monitoring of the business throughout its lifecycle is important because it can help lenders assess which customers to target for marketing, acquisitions, portfolio management and recovery and focus on interacting with businesses that match their risk appetite.
One of the advantages of a holistic risk score is its efficiency. Having a single, data-driven score can help lenders make better-informed decisions, faster by reducing the need to gather and analyze data from multiple sources while potential customers wait for a decision. This can also help lenders make a more objective assessment of which terms and interest rate would be appropriate for each small-business customer. A solution that’s easy to use and integrate with existing business processes may also help automate some of the decision-making process.
Quicker onboarding, tailored offers and ongoing, proactive account management can play a significant role in the success of a small business, and lenders that provide these benefits may get a head start on customer loyalty in this important market.
Later this year, we will be introducing CreditVision® for Business Risk Scoreii. A next-generation business delinquency score that will layer consumer, business and alternative data to deliver new insights into the health of a small business.