SMEs form an important part in the growth of emerging economies. As per a World Bank report, formal SMEs provide close to 60 percent of the total employment and contribute close to 40 percent of the GDP in developing countries. These percentages shoot up, as soon as you add informal SMEs to the count. While these SMEs and micro SMEs are adding to the growth of their countries by way of creating more jobs and national income, an estimated approximate of 600 million jobs need to be created over the next 15 years in order to keep the global workforce engaged. Although this arrangement might seem extremely well-placed where every youth has a job and SMEs add to the growth of their country’s economy, behind the scene a different story plays out.
In most countries, SMEs are struggling to acquire enough credit to keep their company afloat and operational. Most SMEs are turning to traditional methods of financing their ventures such as borrowing from friends and families, taking personal loans, and charging their business expenses to their personal credit cards. Needless to say, while these methods might be able to fuel the business in the short term, they are not feasible when an entrepreneur is thinking long term growth. SMEs need to have their working capital and large investments taken care of in a much more formal manner, a method which is pretty much missing in today’s scenario when it comes to traditional banking.
Approximately 70 percent of SMEs (small, micro, and medium) lack access to formal credit, thereby creating a credit gap of almost US$2.6 trillion, formal and informal SMEs taken together. This gap started forming ever since the sub-prime crisis of 2008 and the gap has been widening ever since. Whether it is the regulatory framework that banks have to abide by which demand that businesses with high credit rating and net worth may receive bank-approved credit on priority, or the methods which make processing small loans for SMEs a rather cost and resource intensive process, SMEs are increasingly becoming wary of traditional banking processes.
It is at this point alternative SME lending solutions entered the market and created new hope for SMEs. Alternative lending institutions (peer-to-peer lending platforms), with the help of fintech, have been able to address all those issues that had become an impediment to SME growth when it came to credit and financing. With quick loan origination processes, single-point dashboards ensuring maximum transparency between lender and borrower, and easy disbursements and repayment options, credit financing has become way easier for SMEs. Alternative lending institutions have located the issues in traditional banking that was acting as a barrier for SMEs while applying for loans. Alternative lending industry pioneers researched and found out the various kinds of financing needs a typical SME has and created custom lending solutions fit for their various needs.
1. P2P lending –P2P lending is the most well-known and sought-after alternative lending solution opted for by SMEs. With the thought of democratizing lending, some companies created a common platform where individuals can take unsecured loans from other individuals, at better and affordable rates. This method does not require lengthy paperwork and the low-interest rates also make this option a rather attractive one for small business owners and proprietors of informal SMEs.
2. B2B lending – Pretty similar to P2P lending, B2B lending caters to businesses and helps SMEs access funds directly from online investors, both institutional and individuals. Like the former, B2B lending cuts intermediaries like banks along with their complex loan origination processes and provide quick financing at comparatively lower rates to borrowers.
3. Crowdfunding – This has become one of the most popular solutions for raising funds to finance a product or a project. The best part about crowdfunding is that it not only helps in raising early-stage investment, but also helps the individuals and businesses seeking it presell products, obtain social proof and market validation, engage with their customers from an early stage, build loyal communities, and also crowdsource creative ideas.
4. Equity-based crowdfunding – A subsegment of the former, equity-based crowdfunding allows entrepreneurs of both startups and SMEs raise early-stage investment via an online marketplace that provides them direct access to angel investors, venture capitalists, and even individual investors, in exchange of equity in their company. This alternative lending solution does not only solve credit financing problems for entrepreneurs, it gives them access to their investors know-how, tie-ups, network and more, which can work in their favour as they work towards scaling up their business processes and expansion.
5. Donation-based crowdfunding – As the name signifies, donation-based crowdfunding allows entrepreneurs in the social sector, working for charitable and social causes raise funding from investors who do not expect any financial gains or material returns from their investment.
6. Invoice trading – This is a relatively new alternative lending solution which has gathered a lot of momentum within a very short period of time. This solution specifically solves the working capital problems of SMEs by taking care of their accrued receivables. Entrepreneurs of small businesses and SMEs often find themselves with invoices that are yet to be paid and over time, non-payment of these receivables may lead to bankruptcy and closure of the SME due to their inability to meet daily operational expenses. Invoice trading helps SMEs address this issue by selling their invoices to institutional investors or to many individuals for a discount.
Apart from the above-mentioned emerging trends in the field of alternative lending solutions that are some other solutions, as well, which are focused on certain specific types of SME needs. For example, debt-based securities, allows investors, both individuals and institutional, to invest in long-term investments, especially in businesses dealing in renewable energy. In fact, this is one of the trending alternative lending solutions for various Green tech companies that are trying to do their bit in saving the planet. Microfinance is yet another example of a specific type of alternative lending solution that is targeted, especially, at small and micro businesses, as they otherwise don’t qualify for a bank loan. There are a number of non-profit microfinance organizations around the world that are helping budding businesses grow and branch out, globally.
With the help of fintech and access to Big data and analytics that can help them make quick, informed decisions and offer instant loan origination services to SMEs, alternative lending institutions are filling in the credit gap which are more prevalent in the continents of Asia and Africa. It’s only a matter of time till they close in and fill the gap for good.