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Smart Lending to Small Business: Combining Personal and Business Credit for a 360˚ View

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The second in a two-part blog series by Pam Dodaro, Executive Director of Business Solutions at TransUnion.

According to the Canadian Federation of Independent Business (CFIB), nearly half of Canada’s small businesses have applied for some form of financing in recent years. The smallest of firms are nearly six times as likely to be rejected for a loan than mid-size firms. Often, this is because lenders don’t have ready access to information that will help them make informed decisions about risk. This can result in missed opportunities for growth on both sides: small businesses can’t get the credit they need, and lenders struggle to expand their portfolios in this market. Pam Dodaro looks at how recent developments in data and analytics now make small business lending less of an art and more of a science.

Overlaying consumer and business data to get a 360-degree view

In our previous blog on small business lending, we saw how a business owner’s personal finances and the finances of the business are often commingled. Using the example of Pam’s Pizza, my (fictional) small business, we saw how personal credit history was used as a proxy for assessing a credit application for the business. We also noted how this practice results in several weak spots for lenders.

Qualitative decisions may be fraught with human bias, while decisions based on limited data could miss important clues about future behaviour. To better assess risk at each stage of the business lifecycle, from start-up through to growth and maturity, lenders need data and tools that can provide answers to fundamental questions:

  • What do I know about this business?
  • Why does the business need credit?
  • What stage of the business lifecycle is it in?
  • What is the structure of the business?
  • Who owns the business?
  • What other businesses are they involved in, or have they been involved in?
  • What do I know about the owner’s credit history?
  • What do I know about the business’s credit history?

Getting the big picture

According to a TransUnion analysis, small business credit risk is highest during the first five years of the business. And businesses whose owners are delinquent on their personal credit are generally eight times riskier than those who are not. This could explain why lenders often rely on consumer credit data when assessing risk, especially in the start-up years.

“Businesses whose owners are delinquent on their personal credit are generally 8x riskier than those who are not.”

But is it enough to simply assess the credit risk of the owner? Maybe for small credit amounts and particularly if there is a guarantor. With larger amounts, though, lenders should be more cautious—a good credit record doesn’t necessarily equate to a low-risk lending opportunity. What if I have a good personal credit profile yet know very little about the business I’m running?

And what if, before opening Pam’s Pizza, I used to own Pam and Paul’s Plumbing with my husband—a successful business for over 10 years—but was forced to declare personal bankruptcy following our divorce? Did you know I also own Pam’s Pruning, a garden service that’s in financial distress, and am looking for a business card to juggle my finances? Perhaps there is a silent owner in one or more of my companies—what information do you have on this person, and how will this help you assess the risk of my new business enterprise? As a lender, it’s important to know my previous business’ performance and understand how this will impact my borrowing behaviour. (As the writer of this blog, this is also a good time to remind readers that these situations are all for example purposes only!)

Lenders need to see the bigger picture, not just parts of it, to make confident lending decisions. Which brings us to the big question: What data sources can you use to help you make the best decision?

As we saw in our previous blog, if you look at consumer credit only, you may be missing opportunities. You may also be taking on too much risk by basing your decisions solely on a snapshot of a person’s credit risk, versus a more holistic view of their behaviour over time. New insights that combine consumer and business data provide a more comprehensive view of the dynamics and relationship between the owner and the business, and can help lenders determine different strategies for providing credit throughout the life-cycle of the business.

Assessing risk throughout the business life-cycle

As a small enterprise grows, lenders need to look at how it is managing its business credit. They also need to understand how personal finance and business credit commingle to fully understand the risk.

Let’s say you’ve decided Pam’s Pizza is a good risk after all, and you’ve approved a card for the business. It’s vital that you continue to stay up to date with how the business finances are being managed. You may find that, somewhere down the line, I max out my business credit and can’t pay my suppliers. To keep production going, I use my personal credit card to pay them.

What happens if, a year after Pam’s Pizza goes into business, the nearby high school closes, and sales drop by 50%? I haven’t been able to make payments to my wholesale food supplier for the last two months due to cashflow issues, and they may cut me off soon. Will I be able to make the payment to your card this month?

Understandably, as a lender you can’t always stay on top of each establishment’s unique circumstances. But you can monitor trends and changes in behaviour. Businesses manage supplier credit differently from traditional credit, so any changes in payment trends can be an early warning sign of financial distress. Delinquencies in supplier trades are one of the first indicators that the business may be in trouble, for example. We can see why it’s wise to keep an eye on business performance and risk.

Assessing small business risk: moving from art to science

Just as lending needs vary at different stages of the business cycle, the amount and type of data available changes as the business matures. And the data should be weighted differently, depending on the age and stage of the business. Knowing what to look for—and how to use the data you gather—can be essential to evolving your risk assessment decisions from perception to science.

In the start-up and growth phases, lenders may rely more heavily on data such as the business owner’s consumer credit performance, supplier credit history and firmographic data. As the business matures and establishes credit terms with suppliers and lenders, this information becomes more important to understanding the financial health of the business.

“The biggest challenge to lenders looking to enhance their small business portfolios is not only the lack of data but also the fact that industry data is fragmented.”

If gathering and interpreting new and varied sets of data is so important to safer lending decisions, why aren’t more lenders basing their risk assessment processes on a combination of personal and business data? You can find the answer in our previous blog: the biggest challenge to lenders looking to enhance their small business portfolios is not only the lack of data but also the fact that industry data is fragmented. But with new data and analytics now available, lenders can get a more holistic view of the risk of a small business and answer those fundamental lending questions I mentioned earlier. By combining data on the business and its owner, they can get a fuller view of the big picture and build strategies for credit data scores and auto decisioning throughout the lifecycle of the business.

At TransUnion, we’ve developed risk assessment tools that bring consumer bureau data, business bureau data, supplier data, public record data and firmographic data into one place, providing a comprehensive view of a small business’s credit footprint. Reporting tools help lenders to monitor the performance of a business, taking critical data into account, to enhance risk assessment throughout the business life-cycle. In addition, our analytic capabilities allow us to create a credit score that can be used independently or integrated with lenders’ own scores to help improve and even automate risk decisions at every step.

Lenders that incorporate small business data into their strategies and processes can drive efficiencies and accelerate onboarding, confidently extend more credit to small businesses while minimizing risk, and do all of this in a shorter time—resulting in positive outcomes for all parties. Lenders grow their portfolios profitability, enabling businesses easier access to credit, which in turns helps strengthen the Canadian economy.
At TransUnion, we call this Information for Good®.

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