The small-business financing market is undergoing massive changes with new players and technological advancements. Part of the reason for these changes is the 2008 recession. It's largely credited with causing an exodus of major banks from the small-business lending space. That gap was then quickly filled with new online lenders who are driving a lot of the innovation in the space.
One advantage to these online lenders is that many of them use underwriting processes that incorporate sophisticated data science practices to better recognize positive investments. In addition, loans tend to be underwritten within minutes or hours rather than the weeks it usually takes traditional lenders, such as banks.
With data models that drastically decrease the risk associated with loans, it should be no surprise that existing players with access to capital from other industries have now started to enter the market. One such example is QuickBooks Capital. While it may be new to the space, QuickBooks is rapidly making strides, having lent more than $200 million in cumulative loans since inception.
New players and new underwriting processes aren't the only changes occuring in the space, and we got the chance to speak with Luke Voiles who is the Business Leader, QuickBooks Capital at Intuit, about these ongoing changes and how small businesses can best equip themselves for changes moving forward.
This interview has been condensed and edited for clarity. If you're a small-business owner interested in sharing your story, tweet us at @ValuePenguin.
Luke, can you briefly describe your background?
My background really is credit investing. Prior to joining Intuit three years ago, I worked most of my career in large private equity funds as a distressed credit and special situations investor. Education-wise, I have a license to practice law in Texas—never practiced for a second—but I also have a MBA; and in undergrad, I studied Computer Science and Economics. So I guess I’m "a mile wide and an inch deep," that's how I'd describe it. I'm not an expert in any of these things, but I know enough to be dangerous across the whole spectrum of what a lending business is, and I hope I know when to step back and let the real experts on the Capital team lead.
What are some key advantages of debt financing (loans) compared to equity?
For small businesses, it's just a simple comparison between equity and debt. Equity can be really expensive. If you build a business that's worth $1 million or even $10 million, if you have to give someone 10% of the equity earlier on, the value of the business could be extremely high later on; especially with venture-backed startups. I think that if you can get away with it, not leveraging equity financing early on lets you own and control more of your business over time. For small businesses that do have the history, the data and the credit history, getting debt financing can be cheaper in the long run. You get to control more of your business, and you don't have to give away the equity. It can be advantageous to get debt financing early.
QuickBooks Capital's underwriting process is a bit different compared to a bank's traditional underwriting process. What data points do you analyze and account for that others don't?
I don't know that we're really looking at anything that's dramatically different. If you look at a bank, a bank will likely need two years of audited financial statements and two years of tax returns to get to a validated history of what a small business looks like. For us, we're looking at the same stuff—we're looking at the income statements and balance sheets—but we're just getting it from a different source. We're using six months of QuickBooks Online (QBO) transaction data and six months of app-connected data to help validate and verify the (profit and loss). One of the largest populations of connected apps for our QBO ecosystem is bank transactions. We're able to see and validate the accounting and general ledger entries that users enter into QBO using the bank transactions data.
I wouldn't say that it's something that's dramatically different than what other lenders are looking at, in the most basic sense. Notably, however, we also do have a forward-looking view of what businesses have coming. Most other banks only see the historical patterns. We can actually see invoices that have been booked and historical payment patterns of those invoices, so we can predict the future cash flow as well, so we do have a bit of an advantage in that sense. We also leverage very advanced AI and machine learning tools and infrastructure built by Intuit to clean, validate, and find new attributes used by our credit models. These tools allow us to move dramatically faster as we iterate on credit.
Why don't banks use that same logic, if they can potentially have just as much insight into a customer's cash flow and financial health?
Frankly, from the seat I sit in, I ask the exact same question. I think that they should be able to. They could build a P&L from the bank transaction data alone. If they use the small-business checking account, they'll see the revenue coming in through deposits; they'll see the expenses going out as withdrawals. I think the problem is matching the bank data to what an accounting P&L should look like and matching the accrual accounting to the cash flow accounting. In theory, they should be able to. Some of the big banks are testing products right now to do just that and they will catch up quickly.
Do you only offer term loans or other forms of financing as well?
We only have a closed-in loan product. It's a fully amortizing installment loan: max term is 12 months; max size is $100,000. The average loan we make is actually much smaller; the average size is about $20,000, and the average term is six months. It's a very short-term, fully amortizing, closed-in loan; not a line of credit. A line of credit is slightly different from a regulatory perspective and an underwriting perspective; we haven't gone there yet. We do however have a full loan marketplace where our customers have access to capital from our lending partners and the partners do offer lines of credit, invoice finance, SBA loans, factoring, equipment finance, longer term, and larger loans. Our goal is to help our customers get capital from the source that makes the most sense for them.
Are loans that small because that's mainly what customers are looking for or is it primarily because of what most borrowers are able to qualify for?
It's a combination of both. We actually just launched a larger loan size recently, so we expect that average loan size to come up over time. Mainly, you look at what the QuickBooks Online population looks like: these are really small businesses. Many of them don't have employees; they're self-employed and they don't have that much revenue. We do a debt service coverage ratio calculation on ability to pay so we try to make sure customers are not over extending. We only make loans to customers who have the weekly or monthly cash flow sufficient to pay back the loan. Many of our customers do only qualify for some of the lower amounts, because they are very small businesses that just don't have access to capital anywhere else.
What propelled that loan size increase, from $35,000 to $100,000?
Customer demand. Many of the larger businesses that use QuickBooks Online want larger loans. We were very careful in testing our credit policy and credit model over time. Frankly, we started out making three-month-long loans that were $6,000 in size. So very carefully over time, as we've tested this product, we've gotten more comfortable with the credit model working, and we now feel comfortable taking the risk on slightly larger loans with longer terms.
You have a partnership with Dun & Bradstreet where customers can see their business credit scores. But don't most lenders analyze personal credit scores when assessing loans?
It really depends on which fintech you're talking about. Many business lenders will look to the business credit score if the business has the credit history. We do take a personal guarantee, so we look at personal credit as well; but it's not the determining factor from a credit perspective. The determining factor for credit for us is the business and the business's cash flow and the business's credit quality. We leverage third-party business credit scores when we make our lending decisions. I can't speak for other small business lenders; I imagine they do use both the consumer bureau score and the small-business bureau score, when available.
There's a lot of controversy around lenders using alternative rates other than APRs to demonstrate the costs of their loans, since some feel that those alternative rates tend to be misleading. How do you combat this practice and show customers that certain loans are not as cheap as they appear?
With radical transparency, is the answer. We strive to be the "gold standard" in the lending space and make sure that our customers really understand what they're getting into when they sign a loan agreement. We also have a marketplace where other fintechs make loans to our customers, and we facilitate those transactions as a broker. When we show matches on the match page, we're very transparent: We show the interest expense, we show the APR, we show any and all prepayment penalties, we disclose all fees, and we disclose how much money the customer actually gets when they borrow the money. Sometimes upfront fees come out, and we want to make it clear to our customers that that's the case and we want to make it clear how all the costs impact the APR they pay on the loan.
The product we built doesn't have any fees. It doesn't have late fees; there's no prepayment penalties; it's an interest-cost only based on the outstanding balance that they have outstanding each day. Our product is very simple, and we're very transparent about what it will cost the company over time. It can be difficult for a small business to understand APR versus interest rate for loans that are less than a year long, but we do our best to make sure that they understand what the cost of the loan will actually be.
Does the underwriting process differ for different customers?
It doesn't. We set up the credit policy and credit model to work on the base of customers that QBO has. It just so happens that many of the businesses that use QuickBooks Online are underserved businesses, like you mentioned. They're very young; 40% of the businesses we fund are less than two years old; 46% of people that have applied for a loan with us have never applied for a business loan for their business before. We think 60% would not be able to get a loan anywhere else, based on the data we're seeing.
We really serve this underserved market. We're not differentiating our credit policy for them—we're equal across the board from a fair lending perspective—but our base allows us to serve those underserved populations, which we love. Our mission is to power prosperity for small businesses. And putting money into our customers’ bank accounts does that in the most direct way possible. 90% of QB Capital customers said the funds they received helped them grow their business and 41 percent said that without a loan from QuickBooks Capital, they would not have expanded or improved their business.
Have you noticed any differences in the ways those different segments use your financing?
We haven't seen much of a difference. Most of our small businesses customers are pretty similar in the sense that they just need the money for working capital. They're trying to make cash flow work. Cash flow is one of the biggest challenges that small businesses face. It could be seasonal ups and downs, or just the desire to invest and grow into new opportunities. Small businesses have to skip paying themselves, or the business owner, sometimes to make ends meet. Our goal is to help solve those cash-flow problems that small businesses face every week.
From your personal perspective, are there any obvious red flags for a business that would indicate they aren't ready for a loan or external financing?
If they're not profitable; that's one basic example. Sometimes businesses are struggling to get started. We can't actually lend them money if they're not making enough money to afford the loan. They could be so early that they're just struggling to make it work and get their first client. I wouldn't call it a red flag; I'd say it's great they're pushing and trying to make it happen. They're just not ready for us yet. We root for these customers and hope the other tools in the Intuit ecosystem help them get traction.
So, businesses in those stages: Based on what you've seen, how do those businesses take it to the next level, where they are ready for, say, a small-business loan from QuickBooks?
If you break it down into just the P&L, they need to grow revenue. They need to grow more and maintain consistent revenue and have expenses that are low enough to where they're making money. It's finding that next customer, that next client, and making it work. It's just the basics of building a new business. Finding ways to automate the core business functions like tax, accounting, and finance can free up time to focus on growth.
Do you have any general tips for our readers?
Do your research. There are other ways to get capital besides funding through the debt side. I just hosted and moderated a panel at QuickBooks Connect where we had three women entrepreneurs who have used all manner of ways to raise capital to help grow their businesses. One was able to get grants and win awards from corporate entities to help grow her business. Another used Kickstarter to test the market to understand whether the product she was manufacturing had a product-market fit. She could use that money to help grow and manufacture the product. Others used GoFundMe campaigns to help get things started, borrowing money from friends and family. There are other ways.
Even if you don't qualify for debt financing at the time, be scrappy. You can figure out ways to make things work and grow your business. And when you do get big enough, maybe you'll get a QuickBooks Capital loan. And when that happens, we report back to both the consumer and the commercial credit bureaus to help you build your small-business credit. Right now, we report back to two small-business bureaus, so when you get a loan from QuickBooks Capital, we help you build your credit. Then you can turn around and go back in and see your credit score. We've recently launched a new free small-business credit score from Dun & Bradstreet. Customers can, in theory, get a loan from us, then it'll get posted to their commercial credit, and then they can see an alert that says, "Hey, you opened this trade line, and your credit score is X." It really ties it all back together for the customer to learn about business credit and help grow their business.