Coronavirus' effect on small merchants tests the limits of fintech lending

The U.S. government will shortly funnel trillions of dollars into the economy to soften the coronavirus’ impact on a variety of industries and small businesses. Payment companies that are also lenders will soon find out if it’s enough to save the market.

Firms like PayPal, Kabbage and Square collectively process payments for millions of small businesses. These companies also use those payment flows to underwrite lending and to collect loan payments, often shoring up liquidity for small businesses. Rescue packages in the U.S. and Europe are designed to keep businesses whole during weeks of inactivity, attempting to create short-term sustainability to resume those payment flows over the long term.

“We’re approaching a number of different business segments and working on a number of ways to provide small businesses with liquidy,” said Sam Taussig, head of global policy for Kabbage. “The smaller the business — particularly those that have just gotten into business — are really suffering.”

These relatively new small businesses usually have about 10 days of cash on hand, and “many of these businesses have tapped into that,” Taussig said.

There will be a massive amount of stress on small businesses due to the health emergency, business closures, and in preparing to access the government agencies that will fund the loans. Additionally, the payment companies that also lend to merchants will have to rely on those payment flows returning once businesses open to protect their own balance sheets.

“The fintechs' whole model is predicated on a revenue stream,” said Lil Roberts, CEO and founder of Xendoo, a Fort Lauderdale, Fla., small-business technology company. “The virus has broken that chain. An e-commerce business will still have revenue but for a more local business like a dry cleaner the revenue stream is zero.”

The $2 trillion Senate stimulus bill, which passed Thursday with an expected House vote and the president's signature, adds “hundreds of billions of dollars” in the coming weeks in loans through the Small Business Administration and other sources. An earlier stimulus bill put $50 billion aside for the SBA. Details are still emerging, though it’s likely the government will forgive loans for businesses that retain workers, and the SBA loans are designed to support two months of payroll and some other overhead expenses.

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The Senate coronavirus bill does leave space for fintechs by saying the authority to make loans “shall be extended to additional lenders determined by the Administrator and the Secretary of the Treasury to have the necessary qualifications to process, close, disburse and service loans made with the guarantee of the Administration.”

Fintechs use a mix of payments, lending and merchant services to gain small-business clients, then increasingly own more of the relationship with those businesses. PayPal and Square mostly use existing payment flows to issue small-business credit though other banks. The merchants then repay their loans as a portion of the payments they accept through PayPal or Square.

Kabbage works in the opposite direction strategically. It’s a small-business lender that has incrementally added transaction capabilities to expand its relationships with small business.

Kabbage offers loans to businesses that have unexpected cash flow problems, building on its existing funding and payment services. The payment proceeds support Kabbage’s pay-as-you-go model, similar to PayPal and Square. Kabbage also offers an invoicing feature. Kabbage uses read-only access to bank statements, accounting, inventory and social media, along with automated underwriting.

Square just received an industrial bank license, which will allow it to directly make loans to small businesses. Square Capital’s loans are issued by Celtic Bank, a Utah-based industrial bank. PayPal offers business loans and working capital. The business loans are fixed term with a weekly payment; while working capital credit uses a business’ existing payment flows to pay down the loan. PayPal’s lender is WebBank, which is also based in Utah. Like Square Capital, Kabbage’s lending institution is Utah’s Celtic Bank.

Getting access to the federally backed loans quickly will be key for businesses that aren’t executing payments right now, to ensure that volume returns in the future. “The brick-and-mortar part of small business is broken. It will come back, but if you are in that business, what is the reason for giving loans now?” Roberts said.

Square and PayPal did not return requests for comment by deadline. Kabbage said it serves nearly every type of business (online and offline) and that “temporary” adjustments have been made to its lending underwriting.

Taussig divides the small business capital needs into several categories. Initially the loans are necessary to keep businesses operable, similar to after a hurricane, followed by a stabilization phase which involves paying employees; then a recovery phase.

“A fintech can be the technology arm for the SBA to onboard businesses, to perform fraud mitigation, know your customer and do all other similar tasks,” Taussig said. “And we can deliver that to the SBA and say ‘here’s where to send the money.’”

Kabbage’s invoicing product can be used in the current environment to more quickly and thoroughly underwrite small businesses, Taussig said. “There’s so much noise and chaos and disruption right now. The businesses need to understand when the revenue comes in. How fast can that money go out to their employees and vendors?”

“Government support for these small businesses is absolutely vital,” Taussig said. “We’re indifferent to the actual mechanism.”