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Years after a game-changing crisis struck our economies, passing now through technological innovation changing the finance sector, the rules governing the finance world are evolving; in a changeful world filled with opportunities and ordeals, small and medium enterprises (SMEs) face unprecedented difficulties in recognizing their options.
Holland FinTech aims to improve knowledge of the full scope of those new instruments for SMEs. For this purpose, we decided to explore SME financing together with the different actors of the field, during our FinTech Vortex event on the 26th September, 2017. This gathering of SMEs, investors, and many other fintech stakeholders will create awareness and foster active partnerships in fintech.
To set the scene, we are going to explore this evolving landscape of tools for SMEs throughout the series Fintech & SME, meant to provide keys to grasp the state of the market and its challenges. As a first step, we are going to give in this part an overview of the alternative finance field for SME. The following chapters will concern the investors’ perspective and the non-financing fintech instruments for SMEs.
Alternative finance for SMEs
1 – Context
- What is the background?
In this post-recession context, the finance environment is on the whole still rigid, and access to finance for SMEs is currently a major global concern. Information asymmetries in financial markets increased, leading to restrictions in business lending around the globe. Although bank loans are still the main source of external finance for SME’s, especially in the EU countries, alternative ways are on the rise, and credit proportion in financial structures – while staying essential – may diminish.
Naturally, the importance of traditional finance is still strong. Bank loans and bank overdrafts are the two more used forms of finance, being in some regions increasingly available to SMEs. Indeed, the funding gap in the EU is diminishing as interest rates are declining.
But this local improvement in access to traditional funding does not mean that banks remain SMEs’ best funding option. Overall, the SME financial landscape is diversifying, with more solutions available at a lower cost. SMEs can benefit from accessing these newer forms of funding. And they do not necessarily have to choose between traditional and innovative tools: as the two – traditional and innovative – are coexistent. More, they are forming a symbiotic ecosystem.
- So, which concerns for SMEs?
SMEs, more than biggest players, are sensitive to changes in finance, and the lack of adaptability of the traditional sector to fast-growing and innovative businesses is hard to ignore. The possibility to access finance on alternative terms represents quite an incentive for players continuously confronted with financing challenges. Alternative financing can help SMEs, to vary their assets and achieve disparate funding sources. In this evolving landscape, traditional financing methods somewhat fail small and medium businesses; unable to have access to enough resources, the main propellers of our economies suffer from a lack of capital as we observe an important problem of underserved SMEs. This raises issues of growth and efficiency in some countries, and issues of basic development in others.
- What solutions exist for SMEs?
Financial technology provides a solution to SME financing problem, as it offers tools and means able to combine new financing methods featuring a broader range of opportunities. In the optic of economic development through the SMEs base, these fintech solutions could play a critical role, for they could form new pillars of sustainability and inject vigour into our economies. In order to have a clearer idea of the tools offered, let’s take a brief look at the market.
While traditional instruments are adapted to a low to medium risk/return model (SMEs having decent growth, cash flows, a solid business model and collateral), the set of fintech products tailored for SMBs disrupts this model. It provides tools adapted to a wider range of risk/return ratios, able to cover otherwise ignored potentials. Amongst different categories of service, we can outline several types of alternative finance implements (non-exhaustive list):
- Alternative lenders
Online lending platforms: these providers offer swift funding solutions to SMEs, offering a better cash flow and enabling SMEs to invest in growth factors. They can be Peer-to-Business (P2B) models, balance sheet models or marketplace models.
Crowdfunding belongs to this category (e.g. Crowdpartners). Investors provide resources to a company because they believe in the product/service provided by this enterprise. Depending on the type of crowfunding, the investors lend the funds as a debt, or receive a sample or symbolic gift in exchange of their assistance.
- Asset-based finance
These tools are intended to provide working capital, improve trade and equipment or provide investments. Online factoring (e.g. Boozt24) is one example. It provides a better working capital by eliminating payment delay; accounts receivable are bought for a percentage of the invoice value.
- Equity instruments
Crowdinvesting (equity-based crowdfunding, e.g. Symbid, Seedrs): This form of crowdfunding consists of exchanging funding for equity. The investors furnish finance to the SME by purchasing a share of the company. Other “hybrid” instruments1 exist, such as convertible bonds or mezzanine finance.
- Online supply chain finance
Online supply chain finance is similar to invoice financing in some ways, but differs in critical aspects. Like invoice financing, it aims to shorten payment delays, but it does so by coordinating the supply chain. In this case, the SME is both the supplier and beneficiary.
- Online trade finance
Online trade finance is meant to cut out the complex role of banks in international trade, optimize exchange processes and improve the working capital of SMEs.
Which trends in the market?
There is no way around it: today, emphasis is on the user experience. Customization and modular products is the modus operandi, as we have witnessed in recent improvements to the front end of products. Mobile banking, management software and other products are geared towards delivering a customer-oriented result.
In the online lending business, the ascent of underwriting digitalization is notable. Roboadvisory and algorithm-based underwriting processes are more and more common, providing a sharper view of customers’ liability and avoiding the need for a troop of analysts. Amazon is a good example of the application of this technology, having lend more than USD 3 billion to SMEs since 2012 through a system powered by machine learning tools. Real-time bookkeeping software (as provided by companies like Jortt & Bunq) are emerging, as are cash & payment management solutions, both in an effort to smoothen and clarify day-to-day management of working flows.
The finance landscape in developing countries is undergoing transformations as well. For example, some microfinance institutions in India, and more broadly across the Asia Pacific, are transforming into banks (responsAbility, 2017), illustrating the expansion of such services.
Machine learning is expected to play an increasingly important role in the near future as a new pillar of digital lending as the market hints already. One example would be the use of risk-scoring algorithms, as ZestFinance does with its product ZAML (Zest Automated Machine Learning), an underwriting platform.
The 2017 responsAbility investment report forecasts global growth for the MSME finance sector of 10 to 15%. Ninety percent of their interviewees expect the share of SME financing in their markets to increase, and 80% of their interviewees consider the markets to be moderately or not at all saturated. This report underlines the huge potential for growth in developing countries (i.e. implantation/creation of fintech startups in Africa see FACTS). The biggest investment opportunities for private equity market are in Asia (p. 23).
Naturally, challenges are raised by the shift in the market, such as the development of broader regulations by public institutions and a widened access to financial services (according to responsAbility, only 53% of adults in developing world have an account in a formal financial institution).
According to an OECD report, Financing SMEs and Entrepreneurs 2017, “the G20/OECD High-level Principles on SME Financing call for strengthening SME access to credit, while supporting the diversification of other financing sources.” (p. 10). Alternative tools such as asset-based finance and lending platform are expected to grow significantly in the coming years, following the trends of years (23% in the Americas in 2016). B2B solutions will increasingly interest investors.
The global European P2P lending market, including SME loans, is projected to reach USD460 billion by 2022, a market increase from USD26 billion two years ago, with France, Germany and the Netherlands as front runners.
The MSME market in developing countries should experience a decent growth by the end of the year, with an expected 5 to 10 per cent growth in Latin America and Sub-Saharan Africa, 10-15 in North Africa and the Middle East, and less than thirty in Asia-Pacific. These numbers give hope in regard to the issue of economic development and unemployment, which can best be resolved by the culture of a SME-friendly environment.
The potential of fintech for SMEs seems vast; a developing customer base, blooming technology, and a global craving for resources in the race against critical challenges. It is hard to overlook the realm of possibilities opened via the keys of financial technology, the meaning brought by such solutions is heavy, their ability to promote progress substantial. If today’s nascent technology can improve SME’s access to capital and financial management, following this path could lead to a structure enabling the creation of an optimized business landscape, with all the implications this carries.
By Jean Leguy, Research Analyst at Holland FinTech
Want to learn more about Holland FinTech and the insurtech firms in our network? Join us at our FinTech Vortex event in the Hague on September 26th, 2017. Tickets available here.
 OECD report, New Approaches to SME and Entrepreneurship Financing: Broadening the Range of Instruments, p. 32
 Survey on the Access to Finance of Enterprises in the euro area − October 2016 to March 2017 − The financial situation of SMEs in the euro area, p. 13
 OECD report, New Approaches to SME and Entrepreneurship Financing: Broadening the Range of Instruments, p. 17
 OECD report, New Approaches to SME and Entrepreneurship Financing: Broadening the Range of Instruments synthesis, p. 7