Tighter Lending Puts Smaller Companies at Risk, But There’s a Simple Solution

Small businesses are too big to fail. We need a financial system that works for businesses of all sizes.

By Chris Atkins

We’re entering a period where many small and midsize businesses, especially new, less established businesses, are facing an increased risk of failure because they can’t borrow money affordably — or at all. 

Surveys from the Federal Reserve and the European Central Bank confirm what many businesses already knew: Banks are tightening their lending standards and making it more difficult for companies to secure loans and lines of credit. Unsettled by a string of high-profile bank failures related to the assets they hold and a quick-moving deposit base, lenders are trying to protect themselves, first, from being the next bank to have liquidity issues and, second, on the credit side in the event of a long-promised recession. 

Compounding this, the recently released Small Business Economic Trends report from the National Federation of Independent Business (NFIB) found that small businesses experienced more challenges securing their most recent loan than previous attempts and that financing is their top business problem.

It may be tough to read this, but some of this is good for the macro economy. The natural business cycle requires that unhealthy businesses (think deeply unprofitable, with no product or market fit) fail and those resources be allocated to healthier, more promising efforts that will make our economy stronger. 

But the way that rate increases contribute to this end-state is through blunt force at best. Many healthy businesses will, without help, succumb to cash flow issues and cease to exist.

The problem is that this help has historically come from banks — help that is drying up in record fashion. According to the Fed’s survey, bank lending dropped by $105 billion in March 2023 alone, which leaves nonbanks and lending substitutes left to pick up the slack. Thankfully, nonbanks now account for half of outstanding loans to small businesses, more than double what it was 30 years ago. 

To ensure a world where healthy businesses of all sizes thrive, we have to move away from the status quo approach to lending and embrace a system and solutions that use advanced technologies and innovative applications of data to reduce the risk of small business credit.

Reduce or remove risk in the financing equation

For starters, that means building financial services that remove risk from the equation. One of the biggest obstacles for many businesses, after all, is being seen as too new, too small, too undercapitalized — “too risky” — to qualify for traditional bank lending, even if they have a steady stream of sales and experienced leadership guiding operations. 

Consider this: If a successful big-box retailer were to come to a lender and ask for a loan, that’s an easy decision because everyone knows that retailer is a very strong company. 

Yet if an entrepreneur who launched her company five years ago applies, there’s a lot of relationship building and due diligence required before the lender is able to say “yes.” Why is this? Because lenders that are bound by traditional underwriting need to aggregate information to ensure they can get paid back.

But what if it were possible to provide funding to a smaller company without taking those standards into account? 

Many smaller businesses wait 60, 90 or even 120 days to receive payment from some of the world’s largest enterprises — companies that may be sitting on billions in otherwise unused capital. 

If we can incentivize these large companies to take those funds and pay invoices days or even weeks early, a small business can receive badly needed funds without taking on any new debt. The payments, after all, are for work or product that has already been completed. 

Not only does this process provide businesses access to funds quickly and easily, this approach also is one of the truly rare win-win scenarios in modern finance. Smaller companies receive the funds they need, in exchange for granting a small, variable discount that is highly desirable to their customers. 

This is the basic early payment model that our company, C2FO, has pioneered and refined over the past 13 years through our platform.

Replacing financing’s red tape with flexibility through data

Just like dynamic discounting has revolutionized invoice discounting, other working capital finance solutions need a new vision, too.  

Factors and other finance companies specializing in working capital often use data related to a company’s invoicing to determine creditworthiness in a nontraditional way. This is workable for small and riskier businesses that need funds and are unable to access funds in a risk-acceptable way, but for nonbank working capital finance companies, it’s deeply unscalable as it requires a large amount of personnel time to pore over invoices on a daily basis. 

To compensate for this, most have burdensome documentation requirements and even lock businesses into long-term, inflexible contracts on top of charging higher rates. These components make the total cost of ownership much higher than it could be. 

But imagine what would be possible if we leaned more heavily into scalable data. 

We could instead create a world where these smaller companies are able to conveniently and quickly access capital in the places they’re already working, perhaps through the marketplaces or software platforms they use. 

After all, many marketplaces and software platforms have access to data that can help assess a small business’s risk. This is how C2FO’s Capital Finance solution operates. 

For example, take the example from earlier of a large enterprise paying the invoice from its small business supplier. Everyone knows — based on the enterprise’s finances and its own payment history as recorded by the software or marketplace — that it will eventually pay that debt.

That knowledge — that confidence of payment — could be used to quickly assure potential lenders that a small business is a good bet and highly likely to repay the funds that it borrows. 

This could dramatically increase the number of funding requests that are approved. The access to capital by smaller businesses would truly be unprecedented and safer for lenders, too. 

Small businesses are too big to fail

Smaller businesses are too important to our global economic health to ignore. According to the World Bank, small and medium enterprises (SMEs) represent more than half of all jobs. In emerging economies, their contribution is even greater — SMEs create about 7 out of 10 jobs. 

And that doesn’t begin to account for the contributions that small and midsize businesses make to larger enterprises by providing essential goods and services through the supply chain. If SMEs struggle, so will the big businesses that rely on them. Humanity itself will struggle because a considerable number of innovations come through these smaller, scrappier companies.

A lack of working capital isn’t just a problem for small businesses. Left unresolved, it’s a blind spot in the global financial system that can hurt us all.  

That’s why we can’t simply ignore the effects on smaller companies when downturns and recessions put them at existential risk. We must build a better financial system that makes it possible for those businesses to not just get by but thrive through difficult conditions, so they can deliver the progress that humanity needs during the next business cycle and beyond.  

Chris Atkins is president of Capital Finance at C2FO, the world’s on-demand working capital platform, providing fast, flexible and equitable access to low-cost capital. With a mission of ensuring that every business has the capital needed to thrive, C2FO has delivered more than $275 billion in funding around the world. Capital Finance is C2FO’s lending business, which uses proprietary data to lower the hurdles and risks to traditional working capital finance.