Fintech's Game-Changing Opportunities for Small Business

 

In the new book Fintech, Small Business, & the American Dream, Karen Mills describes how technology is opening up new capital for entrepreneurs. Around the corner: The transformative benefits of AI and big data.

 Artificial intelligence, machine learning, and big data will transform financial services and small-business lending long before they impact driverless cars, predicts Harvard Business School Senior Fellow Karen G. Mills. “As we speak, large banks and fintech providers are working on solutions that will dramatically change the options for small businesses.”

Her new book, Fintech, Small Business, & the American Dream: How Technology is Transforming Lending and Shaping a New Era of Small Business Opportunity, will be published April 4.

The book explains why small business is key to the United States economy, and how innovation in financial services will reduce the friction and barriers in small-business lending, helping more of them thrive. In our Q&A, Mills, who served as a member of the Obama Cabinet and headed the US Small Business Administration from 2009 to 2013, outlines the challenges and opportunities facing small businesses, the rise of fintech innovation, and the policy implications for regulation.

Martha Lagace: How do you define small business?

Karen Mills: Small businesses are all different, of course. While I define them the same way the US Census does, as any firm with fewer than 500 employees, in my book I focus on three kinds: sole proprietorships, Main Street businesses, and suppliers. All three groups seek financing from loans and have traditionally used banks as their source. 

Of the 30 million small businesses, 24 million are sole proprietorships. These are important livelihoods for Americans and the number is growing with the gig economy and the opportunity to work remotely. Then there are about 4 million Main Street businesses: coffee shops, dry cleaners, and car repair operations, for example. Another 1 million are suppliers like small parts makers or B2B service businesses, which is a growing segment.

“Decisions we make over the next several years will influence large parts of our financial services systems.”

Only a relatively tiny number of US small businesses are the high-growth ones funded by venture capital. While these entrepreneurs are critical to innovation and the creation of the next companies like Google, they do not make up a large part of the small businesses community who are seeking loans. 

Lagace: How does the US small business landscape look now?

Mills: There are 30 million small businesses and they are absolutely critical to the US economy. Half of the people who work in this country own or work for a small business. So that’s half the jobs. Sometimes small businesses don’t have a seat at the table with policymakers in Washington or in economic models, but they are, in fact, vital to job creation, economic mobility, and the fabric of our communities.

The Bright Future of Small Business in America

Karen Mills provides an example of the bright future of small businesses from her new book, “Fintech, Small Business, and The American Dream,” with the story of Ron Siegel and his pursuit to start When Pigs Fly, the now popular New England bakery.

Lagace: As you write in the book, the number of small-business starts has been declining. Why?

Mills: This decline in starts is extremely worrisome. We used to average 500,000 to 600,000 small businesses starting every year in the US. That fell abruptly in the Great Recession and has not come back. There are a number of theories about too much regulation, for example, or too much student debt, but it is a problem because small businesses provide a path to the American dream. 

Traditionally, immigrants have over-indexed in small business starts. That is the story of my family. If we want to have a more equitable economy, if we want America to continue to be the land of opportunity, we need to pay close attention to this trend. 

Lagace: What are the sticking points in getting access to capital?

Mills: This book has its origin in the time I spent at the US Small Business Administration beginning in 2009. We were in the midst of a terrible recession. In the first quarter I was in Washington we lost 1.8 million small-business jobs because credit markets froze, causing tremendous difficulty for the small-business owners. I saw how devastating it was when lending froze, and how much of a lifeline it was when we could revitalize the lending marketplace. 

When I came to Harvard and began to study small-business lending, it was clear there were structural issues. It was not cost effective to make a small-dollar loan using a traditional relationship manager. We identified a funding gap in the smallest dollar loans—those under $100,000. The smallest businesses who wanted the smallest loans were not being well served, in part because it was hard to know whether they were actually creditworthy. 

The advent of technology and the entrance of new fintech entrepreneurs began to change that by improving the speed and ease of the small business customer experience, and making their financial activity more visible to potential lenders. 

Lagace: How much do small-business owners want fintech?

Mills: When owners were able to go online, fill out an application in minutes, and get an answer the same day and money in their bank account the next day, they flocked to the new lenders. Some issues arose quickly, though, such as high prices and bad actors charging hidden fees. 

The initial innovation that fintechs brought was in the front end of the application process, automating it and making it digital first. Soon, however, big banks woke up and realized they did not have to cede this market to the disruptors. JP Morgan, Bank of America, and Wells Fargo all started working on new solutions. Big tech companies also got involved. Amazon, PayPal, and Square developed lending operations, and American Express and Capital One entered the field. Now there is a wide array of large and small companies investing deeply in tech, all centered around recreating the lending experience for small businesses. This is incredibly exciting. 

Lagace: Regulation: What are the hurdles?

Mills: In the book, I have two chapters on regulation. Often people find regulation boring, but we are at a critical juncture. Decisions we make over the next several years will influence large parts of our financial services systems. In the US there are seven agencies overseeing banks and lending, yet issues relevant to small-business lending—such as disclosure rules—have often fallen through the cracks. For example, if you are a consumer and you buy a truck, all costs and financing fees must be clearly disclosed. But if you buy the same truck for your snow removal business, you’re on your own. This must change. 

A more complicated set of regulatory issues is looming around big data and artificial intelligence. My book focuses attention and predictions on what the world will look like as big data, AI, and machine learning come into financial services—lending in particular—in full force. This trend will be transformative. With the ability to aggregate and organize data and analyze it rigorously, lenders can have more predictive algorithms about who is creditworthy, and small business owners can have a dashboard that will help them understand and predict their cash needs. These two activities could perhaps improve small business longevity and maybe turn around this worrisome trend in small business starts. 

But they also come with a set of questions that demand thoughtful attention. The UK and Europe are ahead of the US, making it clear that customers own their banking data and can designate it to be available to a third party. Open data and open banking are important so that data streams are available to multiple financial institutions and entrepreneurs who could provide new products and services. Borrowers could be smarter about their cash needs and how they access capital. 

We have a long way to go in Washington to be fully engaged and intelligent about these issues. Fortunately, small business is one place where there is a lot of bipartisan agreement. I believe we can make progress and give small businesses the results they deserve.

Martha Lagace is writer based in the Boston area..
Image credit: andresr

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Book Excerpt

A Platform to Rule All Others
From: Fintech, Small Business & the American Dream: How Technology Is Transforming Lending and Shaping a New Era of Small Business Opportunity 

By Karen G. Mills

[A] business owner has one system, perhaps QuickBooks or Xero, for their accounting software, one portal for bank transactions, another like HubSpot for marketing, and a separate payroll system such as ADP or Gusto. In addition, there is a separate healthcare or benefits portal and taxes are often paid offline. 

Ask small businesses about their concerns and they often mention their worries about forgetting to make a quarterly payroll tax payment or coming up short because they neglected to put away the cash that they will owe. They fear that they have not planned well for seasonal cash needs, when they have to pay for a big order of inventory, or when a large customer pays late. In a large business, enterprise resource planning (ERP) systems take care of cash forecasting, based on an integrated platform that draws on sales systems, supply chain systems, and manufacturing and product data. 

A similar system for small businesses would combine at least four key activities: banking and payments, loans and credit, accounting, and tax. The key to the dashboard’s value would be to give more visibility into a business’s future cash flows. One can see the value of knowing more precisely when future lean periods or shortfalls might be coming up, and having the opportunity to set aside a rainy day fund. This transparency into future cash flows could benefit a growing business by giving it the confidence to make a large investment decision, such as expanding or buying new equipment. In this “utopian” world, fewer good businesses might fail, and more businesses would have the confidence and financial resources to grow successfully. 

A cash flow dashboard would not just benefit the small business owner. It would also create valuable information flow for a lender. Today, lenders such as Amazon, American Express, and Square rely on transaction data from their platforms. But for small businesses that do not sell at retail, lenders do not yet have the equivalent real-time data on their prospects. A platform that provides an intelligent combination of revenue, receipts, orders, payments to suppliers, and other expenses would help a lender provide credit at the push of a button. Businesses could proceed more securely, knowing they had greater cash buffers, and lenders would have the benefits that cash flow transparency lends to the underwriting and risk assessment process. 

The basic technology to create a connected dashboard exists today. Why, if it is what small businesses want, has it not been developed? Today, each data stream lives within the purview of a different provider (e.g. TurboTax or Visa), each of which may or may not be inclined to provide access. Some of the data, such as banking information, is not controlled by the business owner. This is why Open Banking initiatives in Europe and the United Kingdom, which gave ownership of banking data to consumers and small businesses, were so momentous. […]

There is no question, however, that small business intelligence will develop quickly on the coattails of other areas of big data and artificial intelligence. Combining data sources and using analytic techniques to understand patterns and create predictions is happening already in numerous areas such as marketing and customer acquisition. These same capacities will be the foundational elements for creating an intelligent small business financial platform or dashboard.

Excerpted from Karen G. Mills, Fintech, Small Business & the American Dream: How Technology is Transforming Lending and Shaping a New Era of Small Business Opportunity, published 2019 by Palgrave Macmillan. Copyright (c) 2019 by Palgrave Macmillan, reproduced with permission of SNCSC. All rights reserved.