Comment by patio11 | Hacker News Reader

Comment by patio11 | Hacker News Reader

When I was running my own software business, we needed one pervasively for cashflow management. They're rather difficult for small businesses to secure from traditional financial institutions in the US, especially post financial crisis, and the international character of my business didn't make access easier.

The initial limit most banks floated to me was 10% of top-line revenue, but once they heard what topline revenue was (low to mid 6 figures), they generally suggested withdrawing the application and getting a credit card issued instead. I believe this is primarily because they thought it was unprofitable to underwrite the line of credit rather than an early denial for probable credit risk.

I ended up with ~$200k available on credit cards but couldn't get a line of credit through a traditional lender. Since I needed one, I ended up getting it through OnDeck, which charged 36% APRs. While I was not thrilled about that number, at all, it protected me from having to raid family finances to support the business several times.

(This product theoretically exists in Japan, too, but is extremely hard to access for SMBs without hard collateral like real estate to lend against.)

As a lender the big risk with small businesses is fraud.

Online lenders have automated much of the underwriting process so the main cost is actually CAC rather then staff overhead.

Loans are generally designed to be recoverable (requiring personal guarantees, assets, etc) so even in case of defaults lenders will recover most of their money (recoverability is also the reason it's normally capped at 10%-20%)

However with fraud the chance of recovery is essentially zero, so fraud is typically what blows up lending books.

With small businesses it's often hard to distinguish legitimate business from fraud and that's the real bottleneck.

Why do you think small business loan fraud is so high? What could be done to prevent it?

That’s a great question. I’m wondering the same thing.

The other risk, which does really impact the book, is called "stacking".

The small business goes to OnDeck + 6 others companies and gets loans at the same time. OnDeck can't see these other loans because it takes a while for them to show up in reporting. This is technically fraud (the loan contracts say you can't do this), but most of the time, the intent of the business owner is not to outright steal. Usually they are deep in the hole and trying a last ditch effort to get their business on its feet.

When OnDeck approved the business, they approved them based on the ability to repay 1 loan. Naturally, adding so many more loans is much more likely to lead to default on the insane payments. And because there's 6 creditors, each get pennies.

That’s a great point. Do you think a platform where businesses are explicitly asked to declare other outstanding loans could reduce this problem, at least enough to reduce risk for online lenders to a more comfortable level?

No, the businesses that you need to worry about generally won't track or share this information.

Lenders need to see bank accounts and transaction histories (last 6 months, at least). With transaction records, along with accounting records, it's a fairly straightforward data science task to determine a) whether you are seeing the entire cash picture and b) whether the business has other loans. One should also get tax returns; with those and accounting data one can make a good guess at whether c) the business is just making up numbers when it comes to their operations.

Thanks for the input. That’s very helpful!

I worked for OnDeck for almost four years. I really like their business model/product.

You hit the nail on the head with regards to why banks don't like "small" loans. It costs them almost as much to underwrite a $10 mil loan as a $100k loan, so they know which of the two they prefer.

10% of topline is frustratingly low. To make matters worse, my bank wanted to total debt to fall in that realm so the existing credit cards kept us from getting the loan at all.

The 10% is based around the assets they think might be recoverable if you default - So it’s fair for them to consider all the other companies/debt which will be fighting for a slice of that pie in a default scenario.

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