How to Start a Lending Business - Build the Next Great Fintech
Like many modern industries, the market for loans (especially ones for SMBs) is full of opportunities for alternative lenders. With 60 million people in the US either unbanked or underbanked and trillions of loan dollars on the line, lending is one industry where new entrants can not only make money but also offer credit options that previously did not exist.
For SMBs, getting access to capital can be crucial for buying equipment, leasing office space, and for covering expenses like payroll or corporate tax. Right now, many startups and SMBs don’t have access to the cash flow they need - according to a recent study, only 40 percent of SMBs in Canada believe they can maintain operations for more than six months with their current cash flow. Since SMBS often don’t have the history or financial record-keeping ability that their larger counterparts have, getting a loan is more difficult than it needs to be - leaving plenty of room in the space for new occupants. But is starting a lending business right for you?
Fintechs Have an Advantage
Financial technology companies, such as Railz, can use tools like APIs to make financial data easier to manage - giving lenders more information on the businesses they help fund and SMBs a chance to raise additional capital. Normalizing data across multiple platforms, giving you access to accounting information in real-time, and providing a reliable new way to generate a credit score are just some of the ways technology can give lenders a leg up.
But if you’re thinking about taking the next step in giving out loans, where do you start? Here are a few things to think about when starting your lending business.
- Make a PlanUnlike other businesses, the business of loaning money or providing businesses with credit comes with its own set of administrative challenges. First, you’ll need to register your business as a corporation or other legal entity, as well as register for taxes. You should also make sure you have a business plan for underwriting your loans (eg. choosing the criteria a lender will need to meet to receive capital); and have staff such as an accountant, underwriters, and bookkeepers on your payroll. You’ll need access to lawyers to make sure you’re eligible to operate in each jurisdiction, and to make sure your loan agreements are legally sound - despite your best efforts, if the SMB fails to make payments on their loan, you’ll need to be the one to collect the final amount.
- Get Access to CapitalWhether you’re looking to fund startups or SMBs, the first thing you’ll need is capital - and plenty of it. If you’re planning on lending from a pool of investor money, decide on the average loan amount based on your capacity: are you looking to lend out $35-50,000 in the capital, or 2 million? Keeping expectations transparent and reasonable upfront can save you - and the businesses you lend to - a lot of time, and help you create a targeted business model early on in the process.
- Refine Your Business Model Are you providing loans based on easy access to financial data? Using assets as collateral? Are you targeting one-man businesses or larger operations? The final business model you choose for your lending business should have a clear value proposition, and ideally, be tested with your target market. What kind of businesses do you want to lend to? Who is typically in charge? Are they looking to get loans to cover initial overhead and equipment costs, or looking for ongoing infusions of cash as they get the product up and running? With a lending business, the more specific you can be, the better - being specific and transparent with the kinds of businesses you target can help you find the ideal population for your loans, as well as giving you access to data on the industry such as typical accounting ratios, time to collect receivables, income trajectory, and financing needs.
- Focus on UnderwritingLike any business, a lending business or fintech will need to focus on its strengths in order to survive. And if you’re an investor offering credit to other businesses, your method of underwriting will set you apart from others in the market. How will you decide who gets a loan? Are you using alternative data? Credit scores?Taking the time to build a risk model is worthwhile, especially at the beginning of your enterprise - whether you’re using credit scores or other alternative sources (such as a Railz credit score or normalized accounting data), you’ll need a system in place to make sure your metrics are consistent, reliable, and compliant - not to mention fast and easy to use. Happy lending!
Kristen Campbell is a freelance content writer based in Calgary. She has written for a wide variety of companies in the fields of healthcare, banking, and technology. In her spare time, she enjoys writing stories, reading stories, and going on long walks (to think about her stories).