Last month I read a Globe & Mail article titled “How ‘fintech’ lending could fuel more bankruptcies”. In it, the author questioned whether this increase that’s being experienced in alternative lending activity is a good thing, or if there might be negative consequences. The author also drew a parallel between today’s alternative small business lending activity and the sub-prime mortgage lending activity that led to the great financial crisis of 2008. I felt that there were some over-generalizations in his arguments, however I believe he is asking a very important question.
That very important question is: how much capacity is there in the market for new “good” credit creation in the small business space, and is all of the credit that is being created today “good”? What I mean by “good” is whether it is rational – do the individual businesses have a likely chance of repaying the loan through cash flow? If the answer is yes, then this is credit that is appropriate and the small business economy can handle it. And the creation of it is a good thing as it represents an effective allocation of society’s resources and puts capital in the hands of revenue generating, job creating small businesses.
The tricky part is when lenders run out of new small businesses to lend to and they start to over-extend businesses by convincing them to borrow when they shouldn’t. Or the market becomes very competitive (in terms of the number of lenders competing for a borrower), and in situations where the largest offer wins the deal, some lenders may present offers that are greater in size and debt service requirement than is appropriate for a particular business. Either one of these circumstances is dangerous for the small business owner. No lender wants to make a loan that can’t be repaid, but market participants don’t always act rationally when things are competitive. And to the extent that over-extending the borrower creates more risk for the lender, the lender might simply price that risk appropriately. This solves the risk/reward equation for the lender but it’s a “double-whammy” for the small business who is now even more over-extended due to the cost of borrowing.
The problem won’t be as bad as sub-prime mortgage lending was. That’s because the duration of unsecured small business loans from alternative lenders (typically 6 to 24 months) are much shorter than the duration of a mortgage (10+ years). Long term mortgages made to individuals without the income to repay them were written on the premise that the underlying real estate asset would continue to appreciate – which was a self-fulfilling prophecy for a while as mortgage lending fueled asset prices, which fueled mortgage lending, which fueled asset prices… until it all began to unravel. The short term nature of unsecured small business loans, their immediate debt repayments (problems are felt abruptly by the lender as payments are typically weekly or even daily), and the absence of any collateral that could fuel a bubble means that structurally this market doesn’t have the same potential capacity to become irrational as sub-prime mortgage lending did.
However, it is still an issue worth paying attention to, for the sake of small businesses across the country. Too much debt can be a very bad thing for anyone, and as the alternative lending industry booms, the Globe & Mail writer is right – it could cause some increase in the number of bankruptcies across the country. Small business owners need to educate themselves on budgeting, managing cash flow, and managing their balance sheet. Credit can be a great thing but it can be dangerous, so it is important to know how to use it appropriately. It also doesn’t hurt to deal with a reputable company – at Merchant Advance Capital we take pride in our consultative approach and we proactively structure our offers to ensure we create a powerful win-win relationship with our clients. That’s deeply ingrained in our philosophy and how we want to build our business – even if that means we might grow slower or make less money in the short-term. We’re in it for the long haul and we believe the best way to be successful for the long haul is to do the right thing.