Lending, fast and slow

Small‑business lending bifurcated over the last decade.

If you run your business on a platform like Stripe or Square, and need a working capital line, you can get it fast. The big payment processors have eaten up a huge chunk of the market for short-duration, low-dollar lines. Merchants get a decision in seconds and funding next day.

But if you need a larger or longer duration loan, you're stuck in a much slower world. You're downloading your account statement then uploading it back again to the loan portal at the same bank. You're reading through pages of covenants. You may wait months.

How did fintechs win so much of the market for small business working capital — and why did it stop there?

We've argued elsewhere that vertical software is the new distribution model for financial services. This post covers why we think that's true with lending, especially.

Extending credit with the data on-hand is fast

Stripe, Shopify, and Square all play in this market. The offer shows up where you sell. You drag a slider to pick an amount, accept the fee, and money appears. Terms are short — 9 months on average — and amounts comparatively small, mostly well under $100k. Repayment happens automatically, ebbing and flowing with your sales.

It's worth calling out what a great user experience this is. I've talked to founders who say they never would have applied for a loan, but seeing it teed up in front of them changed their mind.

The great part is the speed. You know you qualify before you apply. The trick is prequalifying merchants based on sales data — processing volume, payment history, customer mix, seasonality — and not considering anything they wouldn't be able to know ahead of time.

The downside of this tight credit box is eye-popping charge-off rates: 5, 10 or even 15%. Payment processors stay ahead of these with high interest rates and fees.

Large loans require data that banks don't have on-hand

Meanwhile, if you need capital to buy equipment, or real estate, or otherwise expand, you're dealing with a bank, and it is not fast.

You are not pre-qualified. You begin a weeks-long process, uploading every excruciating detail of yours and your company's financial life, without any promise of success.

Why is it this way? Because underwriting these deals is hard. Every banker knows they can give back ten years of gains in one bad quarter.

Heterogeneity doesn't help. One week underwriters review a new site for a craft brewery, the next week a renovation at an auto body shop. Different industries have different labor markets, regulatory risks, and collateral valuations. Generally, underwriters aren't actually adjusting the ratios they're looking for by industry: instead they adjust their thresholds portfolio-wide to be on the conservative side.

And underwriters look at everything. Tax returns, financial statements, collateral, insurance, appraisals, and comparables. This rigor mostly pays off! Charge-off rates on business loans from banks hover around 0.5%.

This is not a great product experience. But it doesn't have to be. Business owners looking for expansion capital don't have a better option.

A better option

Let's say you have a property that you rent out on Airbnb. It's going well, and you'd like to expand by adding a second unit.

You can see why Airbnb's payments processor isn't in a good position to give you this loan. They can see your payment history, but not much beyond that.

The local community bank may do better! However, the underwriter would have to make guesses about unfamiliar areas. And you'd have to commit to the application process itself.

The best-positioned party to underwrite this loan is Airbnb itself. They see your reviews, cancellations, calendar; your property's location, amenities, and comparables; how often travelers search for terms it matches; how long travelers linger over photos of the picture windows.

This is why we think industry-specific platforms, whether they're marketplaces or vertical SaaS, are so well set up to make embedded finance plays. They have the data and distribution. They understand their customers' businesses. While these loans can and will remain mostly sold, they can do most of the data collection at the pre-qualification phase. The challenge for them is finding a partner with right technology, capital, and underwriting capacity.

At the end of the day, the lender that can squeeze the most risk out of the portfolio and win on user experience is going to run away with the show. If you're building in this space, we'd love to chat! Reach out at sam@increase.com.