Square Financial Services began operations after completing a long charter approval process with the Federal Deposit Insurance Corporation (FDIC) and the Utah Department of Financial Institutions.

Named Square Financial Services, the bank will operate as an independently governed subsidiary of Square Inc.

The bank will be be based in Salt Lake City and will provide business loans and deposit products to sellers who use its card reader and other point-of-sale services.

Fintech companies typically partner with third-party banks to service products such as small-business loans. Moving forward, Square Financial Services will be the primary provider of financing for Square sellers across the U.S.

Photo | GettyImages

(Note: Do not make any financial or borrowing decision without consulting with your personal, trusted advisors.)

Various funding sources are using their insight into your previous purchasing and financial patterns to, in turn, provide more insight into their lending decision process. For example, using anonymized data from more than 3.9 million subscribers to QuickBooks Online, the company has insight into small business trends and performance indicators that will help improve the borrowing worthiness of a small business — positive indicators that other lenders may not have.

Examples of thousands of such indicators that QuickBooks Capital may include:

• Cash flow: QuickBooks provides a comprehensive picture of cash flow because the subscriber ties in their bank accounts and credit cards, as well as other third-party apps, to get a complete picture of their business.
• Future income: QuickBooks data allows small businesses to get credit for open invoices, work in progress, total inventory, and ongoing projects.
• Relative performance: Because there are more than 3.9M QuickBooks users, QuickBooks makes it easy to understand how a small business stacks up against others like them.
  

Launched by Intuit in late 2017, QuickBooks Capital has loaned $277 million in loans to small businesses for working capital.

Is it working? Intuit and thousands of it customers think so.

60%| Percentage of QuickBooks Capital customers who would likely not get a loan elsewhere
46% | Percentage of QuickBooks Capital customers who had never applied or a loan before.  
$277 million | Loans (cumulative) that have been funded by QuickBooks Capital (during its first year-and-a-half).

Correction: QuickBooks Capital was launched in 2017. An earlier version had the wrong date.

Intuit recently unveiled QuickBooks Capital, a new small business lending product that provides users of QuickBooks access to small business loans up to about $35,000. This new service’s lending process is done using algorithms from within QuickBooks itself. Thanks to Intuit’s big data and machine learning techniques, most borrowers will know whether or not they are approved for a loan in just a few minutes. In this article, Steve King, a partner in Emergent Research and a regular contributor to SmallBusiness.com explains how this and other data-driven lenders are helping small businesses access loans.

Lack of credit is consistently one of the top challenges for small businesses. And for new businesses (those that have been in business less than 5 years), the challenges are even greater. According to the Federal Reserve of New York 2016 Credit Survey: Report on Startup Firms, 70% of young businesses say they need funding to grow. But only 23% of these firms are successful at getting all the funding they are looking for.

70% | Percentage of new businesses say they need funding to grow
26% | Don’t apply
21% | Get rejected
30% | Get partially funded
23% | Get funded

Source: 2016 Small Business Credit Survey. Federal Reserve Bank of New York

Insufficient credit history is why young companies find it hard to get funding

Simply put, they haven’t been around long enough to establish a strong enough track record for lenders to be comfortable providing them credit. And even if they get the credit they’re looking for, small business satisfaction with the lending process is not good

Percentage of successful borrowers who are satisfied with their experience at various lending sources

48% | Small banks
31% | Big banks
23% | Online lenders

How Intuit uses anonymous data to approve loan requests

Intuit has over 2 million small businesses that have agreed to allow the software company to analyze anonymized data in an aggregated format to develop products like QuickBooks Capital. This means Intuit can analyze 28 billion data points in its credit model. (QuickBooks users own their data and have to provide Intuit permission to use their data in this manner).

This database of income-statement, balance sheet, cash flow and transactions data allows Intuit to fully analyze the current financial state of a small business and predict its ability to pay back a loan. It also means Intuit’s credit model has enough data to allow them to lend to young small businesses, even those that have been around less than one year.

Based on the service’s beta customers, this approach is broadening credit availability and making it easier and quicker to get a loan.

Analysis by Intuit of its early QuickBooks Capital borrowers

46% | Had never applied for a loan before.
60% | Would likely have their loan application rejected elsewhere
90% | Say the loan helped their business grow

istock

Also on SmallBusiness.com

Intuit Provides a Peak at Innovative Ways Small Businesses May Work in the Future

Kabbage, the Atlanta-based online small business lender, today (August 3, 2017) announced it has raised $250 million in equity financing from the Japanese technology conglomerate SoftBank Group Corp. According to the announcement, Kabbage has pioneered a financial services data and technology platform to provide automated funding to small businesses in minutes. Kabbage uses data generated through business activity such as accounting data, online sales, shipping and dozens of other sources to understand performance and deliver fast, flexible funding in real time. 

Kabbage plans to use the investment SoftBank to expand its lending products for small businesses and will explore non-lending products and services for these customers. The company currently operates in North America and Europe with plans to expand to Asia.“We invested in Kabbage because their unique automated lending platform leverages open data networks and best positions them to empower small businesses around the world,” said SoftBank Managing Director David Thevenon.

Kabbage stats since its launch in 2009

$3.5 billion | Small business loans facilitated
100,000 | Facilitated loans to 100,000+ small businesses,  more than any other online small business lender
1.5 million | Maintains 1.5 million live connections to customer data

Kabbage is among a group of young companies that use technology to lower lending costs and offer credit faster than brick-and-mortar institutions. However, according to Reuters, while online lending is expanding, the sector, sometimes called “marketplace lending,” has faced growing pains, including softer institutional investor demand due to concerns about loan quality. This has made it harder for such lenders to raise funding, leading analysts and market participants to suggest the sector might be headed for consolidation. In March, Reuters reported that Kabbage was looking to raise a new round of equity funding for potential consolidation, with listed competitor On Deck being one of its acquisition targets. Kabbage has no “specific plan” to buy On Deck, CEO Frohwein told Reuters. “We look at all sorts of opportunities, but it needs to be in spaces that are not similar or overlapping with what we do.”

Learn more at the SmallBusiness.com Guide to Alternative Funding

iStock

The rewards-based crowdfunding platform Indiegogo has partnered with the equity crowdfunding website, MicroVentures, to provide Indiegogo backers the possibility to make equity investments in certain projects. While available, it’s not for every startup or investor.

“Unlike rewards-based crowdfunding, with equity crowdfunding, individuals receive company shares, not just perks, in exchange for their equity investment. Not only can businesses gain the crucial help they need from a broader pool of funders—but investors can support business they believe in, and can even benefit financially if a company goes on to greater heights,” explained Slava Rubin, chief business officer, who announced the program on Indiegogo’s blog yesterday (November 15, 2016).

As SmallBusiness.com has covered over the past three years, equity crowdfunding is possible because of the equity crowdfunding rules passed by the Securities and Exchange Commission (SEC) as part of the 2012 JOBS Act. The legislation allows anyone the opportunity to invest in companies online.

Previously, only a select group of accredited investors that met a certain wealth threshold could invest in early-stage private companies.

“Investing in startups means you may own a piece of the company and are along for the ride, with all the ups and downs. You may not have a seat at the boardroom table, but you can help a great idea come to life,” said Rubin.

The costs of running an equity-raising campaign

While the option is available to Indiego users, don’t expect a mad dash for most project fund-raisers.

According to the NYTimes.com, here are some of the caveats for such an approach:

• The cost of running an equity campaign is very different from a rewards-based campaign. For example, it is free to set up a rewards-based campaign. The platform is paid 5% of the revenues generated for a successful campaign.
• For equity campaigns, creators will need to spend about $7,000 on compliance and regulatory costs before a campaign is permitted to go live.
• The site will then take a cash fee of 7 percent on any funds raised, plus an additional 2 percent in stock.
• Investors will pay a $7 processing fee or 2 percent of their investment, whichever is higher.

Investor, beware

While Indiegogo, MicroVentures and the 2012 Jobs Act make the equity funding option possible, it won’t be for everyone. Before making any investment, know the risks. Startup investing is high risk. As we say often, always consult  your trusted advisors when making decisions about money or legal matters.

Borrowing by small businesses has been on the decline for several years, according to ongoing research by the Small Business Administration’s Office of Advocacy. There are several reasons for this decline–and even economists disagree on the causes. Declining need for capital during a period of slow economic growth is an obvious reason. Another contributing factor could be the increased regulation of banks after 2008 has caused the cost of lending money more expensive, thereby incenting banks to focus on higher margin loans to big businesses.

Another reason, one we’ve reported on for over two years (if you are viewing this on SmallBusiness.com, see above: the SmallBusiness.com Guide to Alternative Financing), may be the growth of “alternative financing” options. In many cases, traditional banks and companies like Sam’s Club and Square are even serving as lead-generating partners for alternative financing companies. Alternative financing, as we’ve noted previously, is not without controversy.

The Small Business Administration’s Office of Advocacy is producing a series of issue briefs on alternative finance options, “including their tradeoffs” (translation: don’t make financial decisions without help from trusted advisors including your accountant, lawyers and several bankers) that outline various alternative financing options. The following is an abbreviated version of the overview of this series.*

What are traditional forms of business financing?

In order to understand alternative financing, it is helpful to consider the traditional mix of small business financing. The most commonly used sources of small business expansion capital in 2007 and 2012 can be seen in the chart below. Altogether, they can also be grouped in these three baskets.

• Personal assets
• Reinvested business profits
• Financing sources originating in banks

Sources of Expansion Financing, Employer Firms Source: Survey of Business Owners, U.S. Census Bureau

What are alternative forms of business financing?

While there is no single authoritative technical definition of “alternative finance,” it can be identified as financing from external sources other than banks or stock and bond markets.Unlike traditional sources of expansion capital, alternative finance draws from other sources and generally over internet platforms, ranging from individual investors to non-bank lending companies. In addition, some definitions emphasize the direct connection of fundraisers with funders, often via online platforms.

Characteristics of alternative finance:

• Rely on new methods of evaluating credit
• Require different criteria for funding (i.e., relying less on collateral)
• They may consider new metrics or indicators of creditworthiness

Types of alternative finance

Crowdfunding

Crowdfunding, the pooling of small amounts of money from many investors through internet platforms, is one of the better-known forms of alternative finance. In the United States, the three most common forms of crowdfunding are:

Donation- and rewards-based crowdfunding | In this fundraising model, investors give money without expecting financial compensation (i.e., donations), but, in the case of rewards-based crowdfunding, they receive benefits such as early access to a new product.

Peer-to-peer and peer-to-business lending | These lending approaches are similar in concept to microfinance platforms such as Kiva. They anonymously connect borrowers (individuals or businesses) with multiple lenders; lenders receive interest in return, which distinguishes them from traditional microfinance.

Equity crowdfunding |  This form of crowdfunding was authorized in the United States beginning in May 2016. In this model, investors receive an equity stake in the company, similar to purchasing stocks.

Some sources distinguish between debt-based securities and peer-based lending. However, in the United States, lenders on peer-to-peer and peer-to-business platforms are technically buying debt based securities, similar to bonds—meaning that these platforms are subject to certain federal regulations.

Two recently emerging models of crowdfunding:

Revenue and profit sharing crowdfunding | In this model, a business receives a loan funded by multiple investors and pays back the full amount based on future receivables, similar to a merchant cash advance.

Invoice trading | With invoice trading, also a form of receivables-based financing, a business sells its invoices at a discount to a pool of individual or institutional investors for cash. This is similar to factoring, except that multiple parties instead of one lender purchase the invoice. Although some sources6 consider invoice trading to be distinct from crowdfunding, it is included here because multiple investors participate.

Online marketplace lending

“Marketplace lending” refers to online platforms that allow one or more investors to make loans directly or indirectly to small businesses. These platforms rely on data-driven algorithms to evaluate the creditworthiness of borrowers, as distinct from traditional banking practices. Installment loans similar to traditional bank loans are available through marketplace lending platforms.

Online marketplace lenders appear particularly significant to smaller businesses. In 2015, the smallest firms were more likely than other firms to apply for financing from an online lender. And the smallest firms were more likely to be approved at online lenders than at large banks or credit unions.

*The full report can be found here on the Office of Advocacy website. Future products in the Alternative Finance Series will include an overview of the regulation landscape and a fact sheet on crowdfunding. As those are released, we will make them available here in support of the work of the Office of Advocacy’s efforts to share this information with small business owners.

The U.S. Treasury Department is exploring options for more oversight of small business marketplace loans (also called “online loans” or “alternative lending”), according to a report in the Wall Street Journal. 

Quote | via WSJ.com

“Marketplace lending firms generally connect potential borrowers with loan funders or investors. Marketplace lenders have expanded in part by offering credit to startup firms that may have trouble getting loans from banks. They maintain further regulation could slow or derail the lending process for underserved borrowers. The leading marketplace lenders originated about $1.9 billion in small-business loans last year, up nearly 60% from 2014, according to a Treasury Department study. The trend is concerning regulators, whose jurisdiction over small-business, versus consumer, lending isn’t as clear.”

As we’ve shared previously, several leaders in this growing niche have formed a trade association and are working on self-regulatory options to bring more transparency to online lending. Such transparency is needed as the Treasury did a sampling of the types of rates offered by three marketplace lenders for small-business loans and found effective annual percentage rates (APRs) spanning from about 7% to more than 98%.

By comparison, small-business loans offered by banks through the U.S. Small Business Administration have rates ranging from 4% to 10%. But those loans have stricter underwriting requirements, so not many online lenders offer SBA loans.

Regulators are exploring the possibility of applying fair-lending rules largely meant to protect minorities and women, to small business loans. The fair-lending rules are the same ones applied to consumer loans and require stricter disclosure than business loans.

via | WSJ.com

Last week we shared the news that the three largest online small business lenders were forming a trade association to address complaints about the information and transparency they provide to borrowers. During the last few days, the need for such a lobbying group has become more and more apparent as the alternative, or “marketplace,” lending industry—both small business and consumer focused—has been battered by controversy and, according to The New York Times, even doubts by investors regarding its longterm viability.

The terrible, horrible part

LendingClub | The company’s CEO resigned after a board review found the company sold an investor $22 million in loans with characteristics violating the investor’s “express instructions.” The company’s stock price fell dramatically after the news was released. (WSJ.com)

Prosper | Blaming a “tightening of the capital markets,” the company announced it was laying off one-third of its employees. (PYMNTS.com)

OnDeck | OnDeck Capital’s stock price fell by more than 34 percent after it reported a much wider loss than expected.  (Barrons.com)

Why the bad news?

Online lenders have been created using a model loved by venture capital investors, borrowers, and lenders. Without the expense of bricks and mortar branches and free from many federal regulations regarding reserve money, these lenders, called “marketplace lenders,” have been able to match consumers and small businesses, hoping to borrow a few thousand dollars, with individuals or Wall Street investors looking to lend money.

Quote from NYTimes.com:

“Just months ago, it seemed marketplace lenders couldn’t churn out loans fast enough. Investors like hedge funds, insurance companies and pension funds were clamoring to buy large pools of these loans, which offered an attractive return at a time of record low interest rates. But in the first quarter, lenders like Lending Club, Prosper and OnDeck Capital had difficulty convincing investors that their business models are sound. Even though the majority of the companies’ borrowers continue to pay their loans on time, Wall Street investors have started to worry about the prospect of increasing defaults.”

What’s next?

The need for marketplace loans by small businesses is a separate issue from the needs by Wall Street for investment opportunities. (We’ll leave all discussion regarding Wall Street to other sources.)

However, as we have shared in the past, the claim by marketplace lenders that small businesses are facing a credit crunch runs counter to the long-running monthly survey of small businesses by NFIB which currently (4/2016) says, “Loan demand remains historically weak, owners can’t find many good reasons to borrow to invest when expectations for growth are not very positive.”

As always, a recommendation

Any type of borrowing or financial decisions should be discussed with your tax and financial advisor as everyone’s situation is different and there are no one-size-fits-all approaches.

The nation’s three largest online small business alternative lending companies — OnDeck, Kabbage and CAN Capital — on Thursday (5.5.2016) announced the formation of an industry trade group. One of the first actions of the organization will be the launch of standardized price-comparison tools, standard explanations of borrower obligations, and greater transparency in information related to all fees and costs associated with loans.

According to a press release from the new Innovative Lending Platform Association (InnovativeLending.org), its formation and the launch of the new comparison tools came as a result of “findings from an industry study underscoring small business customer preferences and priorities.”

The comparison tool, called “Smart Box” (for Straightforward Metrics Around Rate and Total Cost), will enable potential borrowers to compare fees, annual percentage rates and other costs for loans of the same duration.

The formation of the association and announcement of the Smart Box can also be viewed as a form of self-regulation for an industry that has undergone rapid growth, but as we have shared previously, is attracting attention from banking regulators concerning the transparency of information provided to the borrower regarding  all costs and fees related to the loans. The lobbying efforts of the new association, along with the availability of more transparency in the full costs associated with the loans, could help stall government regulations.

“We believe that this type of self-regulatory approach demonstrates the maturation of this space,” said Daniel Gorfine, vice president and associate general counsel of OnDeck.

For certain small businesses and the types of traditional financial services institutions that serve them (banks, etc.), the cost and time tied up in particular types of smaller loans have opened the door to a wide range of alternative financing options (collectively called, “online marketplace lending”) for some types of needs and situations (see the links above). On July 16, the U.S. Treasury Department announced it is studying these new marketplaces. 

Background

What is now called “online marketplace lending” started primarily as a “peer-to-peer” model where individuals could lend money to other individuals or small businesses. Today, much of the funds used for such lending comes from large investors that are funneling hundreds of millions of dollars to marketplace lenders.

“Some of the more established companies, like Lending Club and Prosper Marketplace, have been vastly increasing their volume in recent years, while facing an ever-expanding field of upstart competitors. Even Goldman Sachs is starting an online consumer lending operation that mimics some of the marketplace approach. Without the overhead costs of large banks, the online lenders say they can charge lower interest rates and swiftly make a decision on whether to extend credit. Most marketplace lenders only facilitate the loans, which are held by investors.” —NYTimes.com.

“A fact-finding effort”

The tone of the Treasury Department’s press release and blog post indicates the department’s desire to position its research effort in a non-confrontational context. It is not an investigation, in other words.

“Innovation in financial services is creating new ways for consumers and small businesses to secure credit,” said Antonio Weiss, counselor to the Treasury Secretary. “By soliciting public comments on this relatively new industry, we hope to better understand the potential for online technology to expand access to safe and affordable credit for consumers and small businesses.”

Despite the positive tone, the Treasury Department announcement does indicate its desire to understand how the creditworthiness of borrowers is established and whether lenders should be required to have “skin in the game”—meaning sharing some of the risk in case of borrower default.

How to comment

The Treasury Department is inviting public comment for 45 days, beginning on Monday, July 20. It also plans to hold a series of round-table discussions this summer with input from the $12 billion industry, borrowers and consumer advocates.

A PDF of the Treasury Department’s invitation for public comments, technically called a “Request for Information (RFI),” can be found on its website.