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Venture capitalists have moved on from social media apps and photo filters. The new interest is financial services, especially lending. This may create new options for small businesses looking for new sources of funding.
The PwC/NVCA MoneyTree Report of Venture Capital shows that financial services investments are a strong part of the overall venture capital market. In 2008, the year of the financial crisis, 67 financial services companies received $476.6 million, which was 2.3 percent of the total amount of money invested that year. In 2015, 101 financial companies received $3.3 billion in venture funding, 5.6 percent of the total venture funds for the year. In the first half of 2016, 53 financial companies have received $1.4 billion, or 5 percent of the total venture funding.
The money is going into financial companies in part because of widespread dissatisfaction with traditional financial services companies. Big companies don’t move quickly, and many financial companies were reeling from the 2008 financial crisis. Despite historically low interest rates, many banks tightened their underwriting, leaving small businesses unable to receive funds even if their creditworthiness was unchanged.
Karen Gordon Mills and Brayden McCarthy of Harvard Business School have written about small business lending during the recovery. They note that the underlying problem is that small business loans are less profitable for banks than other types of loans, and the consolidation of the banking industry means that loans that would have been worthwhile for a community bank to offer may not be of interest to a large multinational bank. Technology is allowing new companies to enter the small business lending market through a trend called Fintech.
Some of the new innovations, such as crowdfunding, emerged into this gap. Kickstarter was founded in 2009, well before the JOBS Act of 2012 allowed for crowdfunding of investors. Kickstarter itself was backed by $10 million in venture funding from Union Square Ventures and a group of angel investors. The Kickstarter model provided a way for companies to raise money through pre-sales of products, an innovation made possible in part by changes in technology.
Kickstarter provides an alternative to bank funding, but many of the venture-funded businesses are going straight for bank services. That 2015 class of financial venture deals included Behalf, BlueVine, Dealstruck, Fundbox, Kabbage and Swift Financial Corporation, all of which offer financing to small businesses. The pace of funding is strong; Bloomberg News reports that financial technology deals will hit record levels in 2016.
Most of these firms are offering lines of credit, but a few are offering traditional loans, inventory financing, and receivable factoring. Some offer platforms to help business owners manage payables and receivables, too, as a way to differentiate themselves from their competition – especially traditional banks.
Traditional banks use customer deposits to fund their lending activities; the newer lenders use venture capital backing as their source of funds. Some are receiving investments from traditional banks that like the returns available but don’t want to do the work of offering the loans. The concern that Harvard’s Mills and McCarthy have is that these methods are not well regulated, which could create problems for unwary borrowers. The Credit CARD Act of 2010, which added new restrictions on consumer lending, does not apply to business credit. That’s one reason the market is attractive to venture capitalists.
All of this venture funding going into Fintech creates some great opportunities for businesses to shop around. Owners may find that they can get a better mix of rates, fees and services by shopping around and considering the newer firms. An SBA 7(a) loan through a bank remains a great bargain to fund the establishment or expansion of a business, but the underwriting standards are very strict. Furthermore, an SBA loan only solves one type of financial problem. The entrepreneurial spirit fueling the Fintech startups can help entrepreneurs in all industries, which one of the great ways that the market works.