In a Nutshell: Just as an individual generates a personal credit profile over the course of his or her financial life, so, too, does a small business. Unfortunately, building a commercial credit profile is much more difficult than building one as a consumer. Many small businesses can take five years or more to do so, making it nearly impossible for lenders to assess their credit risk and offer financing — even if they want to. Data and risk analytics company LexisNexis Risk Solutions is helping bridge the information gap between banks and businesses by offering alternative-data-based credit risk assessments for lenders to make smarter, safer lending decisions. By using advanced analysis techniques, LexisNexis Risk Solutions can identify — and resolve — thousands of data footprints to establish a business’s profile, expanding beyond the lender’s reliance on traditional commercial credit reporting and increasing their ability to lend to more small businesses.
In the eyes of the law, your small business is an entity; it exists — and, generally, pays taxes — as a thing that is separate from any individual person (though the extent of this will vary depending on the type of business). So, while your personal credit history can impact your business credit, your business can — and should — establish its own credit history.
Unfortunately, your average small business either has what’s called a “thin file” — read: only one or two accounts — or, no credit history at all. In fact, according to Ben Cutler, Head of Small Business Credit Risk Decisioning for data and risk analytics firm LexisNexis Risk Solutions, only about half of small business financing applicants actually have an established credit profile, and of those, about one half are thin files.
“If you look at, say, a national small business card issuer — typically, they’ll have about a one-in-three hit rate on a credit history,” he said. “The number of small businesses with typical credit bureau-type histories is actually much less than what you’d see in the broader consumer market.”
The problem? Ben says it’s two-fold.
“To some degree, there’s churn in small business — there are many new businesses coming into the pipe,” he explained. It takes time to establish credit, and most new businesses have other priorities, including getting the lights on. “When you think of a new small business — the first thing they don’t do is go out and look for credit.”
The second factor? The same thing that keeps regular consumers from establishing credit: fear of taking on debt.
“I had a discussion with a guy the other day who supplies batteries to auto shops,” described Ben. “Coming out of the recession, he was scared; he didn’t want to take on additional debt. He was basically waiting for things to turn around before he went out to seek credit.”
As with consumer credit, though, failing to establish a commercial credit history can bite you later. Without access to a credit profile to even establish that your business is real, most lenders can’t approve your application — even if they really want to.
“These lenders want to lend,” stressed Ben. He said many lenders, particularly small business credit card issuers, have shown an increased willingness to lend, especially over the last few years, but are being curtailed, in part, by more extensive regulations and, particularly, by the lack of information.
“If only about one in three of those small business applicants have a credit profile, you need to go out and look at other data sources.” That’s where companies like LexisNexis Risk Solutions are helping bridge the information gap, using advanced data analytics to establish alternative credit risk assessments of small businesses.
The 3 Factors of a LexisNexis Risk Solutions Business Profile
The key to developing an effective profile of a small business isn’t necessarily all in the data — though LexisNexis Risk Solutions, which pulls from about 13,000 different sources, has plenty of that. The real trick, according to Ben, is to do something with that data.
“We lean heavily on the technology to combine those sources and resolve them into specific entities, and use advanced analytics on that data — to be able to do things as simple as identity verification, and then, more broadly, credit risk assessment.”
1. Alternative Business Data
Developing a complete risk profile starts with alternative business data, which can be anything from your business’s articles of incorporation to your company’s power bill. Ben says the average small business can operate for five years or more before establishing a typical commercial credit history.
“What they’ll do is go and set up points of contact — they’ll get a phone, email, maybe a website. Then they’ll set up shop, turn on utilities. Depending on the business, they go out and get a business license; they’re registering with the state government.”
While the initial steps taken by a fledgling business are important and necessary, they generally don’t help your new business establish credit. Even the initial inventory purchases or asset acquisitions won’t give your company a commercial credit score in most cases.
They will, however, create a data “footprint” that LexisNexis Risk Solutions can find — and analyze.
“You have all of these data points floating around out there — they’re kind of like footprints,” described Ben. “We can see these footprints typically up to five years before the small business begins to establish a credit profile. They reveal that a business has been there, and they don’t require really any type of credit history.”
Collecting the data is only part of the process. “So you have these thousands and thousands of data footprints, and it’s the ability to gather those footprints — and resolve them into specific entities — that starts to give you insight into the business itself.”
2. Payment Performance History
Of course, a credit risk assessment wouldn’t be complete without an actual assessment of how you handle credit. “We do collect the payment histories on small business,” said Ben. “This would be traditional credit-bureau-type information on a small business. That’s through the relationship we have with the Small Business Financial Exchange.”
As with a traditional consumer credit analysis, LexisNexis Risk Solutions looks at things like on-time payments — and late ones — as well as the types of accounts and overall utilization. If a business, or the people associated with it, have had a bankruptcy or other negative event, it all comes out here.
“We see around one out of three businesses have some type of derogatory experience in their background, or the background of the person associated with the business,” explained Ben.
3. People Connected to the Business
The last part of the profile involves identifying — and resolving — all of the information on the people associated with the business. “We’re connecting people to business — the people side of things,” said Ben. “Because many times a small business is the person, or people, associated with that business.”
This process involves many of the same steps they use when collecting information on the business itself, including taking advantage of similar alternative data types. Ben described it as the same type of information that a business creates when setting up shop.
“[Businesses] typically go through a series of steps, kind of an evolution, before they get to that [credit] stage,” he explained. “People are doing the same thing — people set up phone or email, people are getting utilities. People go to school — people even get licensed.”
The 5 Questions that are Between Your Business and Your Business Loan
So, how does all of this data and analysis actually affect your business’s ability to get a loan? Well, it turns out this (extremely) complex process actually has a simple goal.
“When you think of these footprints,” said Ben, “a lot of times we’re just trying to answer five fairly basic questions.” And, it’s the answers to those questions that decide if you get financing from the lender using the company’s metrics.
1. Is the Company Real?
In an ideal world, lenders could just pull the credit profile of an applicant business and be done with this step; sadly, this is not an ideal world. “If they were going to rely on the credit report to verify the identity — again, millions of small businesses do not have a traditional credit history. You have to lean back on this alternative data.”
So, what types of things do they actually look for? Well, just about anything that can identify the business. “Are we seeing business in trustworthy government sources — does it have a filing with the Secretary of State? Do we see it in more than one source, and how long have we seen it? What’s its length of time on file? Information like this just tells us, ‘Is this applicant even a real business?’ — whether or not it has a credit history.”
2. Is the Company Stable?
Once they’ve established that your business is who you say it is, it’s time to start building the details. For each source, they’ll determine not just if you show up, but what they’re saying about you. They want to know if your business is stable — or struggling.
“So, we look at its standing with government resources — is it dissolved with the Secretary of State, or is it active? Has it been paying its dues? How long has it been at this specific address and in how many locations can we identify this business?”
This is also where LexisNexis Risk Solutions considers the type of business. According to Ben, some types are considered to be more inherently stable than others. “If it’s a franchise, then typically, there’s been some investment there — so it’s more of a stable entity.”
3. Can the Company Repay Its Debt?
Next, comes the number. “Once we’ve seen if it’s real and stable, we see: is it able to repay?” said Ben. “We look at an asset profile, such as, does the business own property — or, do the people associated with it own property? What type of other assets does it have — does it have a fleet?”
LexisNexis Risk Solutions will then look at your business’s current debts and financial pledges. They’ll also look at what debts you owe. “Again, going back to the people — what’s the profile of the people associated with this business?”
4. Will the Company Repay Its Debt?
Of course, there’s a world of difference between able and willing — and LexisNexis Risk Solutions can tell. They’ll delve both into your ability to pay, and how likely you are to do so.
“Here, we’re looking at some of the traditional public records sources,” Ben explained. “Is there a bankruptcy in the background, are there judgments against the entity? Are there tax liens against the small business — or against the person associated with that business?”
He said it basically boils down to, “How long has it been in business, and what’s its track record?”
5. Does the Company Have a Good Reputation?
Here is where compliance comes into play with a vengeance; this step includes checking to make sure the lender is even allowed to lend to your business. “So, we’re looking at negative news sources,” said Ben, “and if it is on the OFAC list [Office of Foreign Assets Control Specially Designated Nationals List]. Is it on other watch lists — are there any government sanctions against the entity?”
This step can also help indicate if the lender wants to lend to your business — or you. According to Ben, sometimes this step can reveal personal habits or questionable activities that would make a lender hesitant to work with a business. He gave an example involving a fellow caught participating in some illicit online behavior — and who was subsequently denied financing.
Making a Difference in the Way SMBs Get Financing
While many lenders are still relying on commercial credit reports — and, thus, denying otherwise qualified applicants — there is still hope for the almost 80% of small businesses who have a thin file, or even a nonexistent one. According to Ben, lenders are finally starting to come around to the idea of alternative-data-based lending risk models.
“We’ve had many discussions about the value of this alternative data, and — the banks are getting that. They’re looking at that option,” he said. “As I’m thinking through the lens of a small business, who is saying ‘I’m too new,’ or, ‘My credit history is too thin’ — it’s evolving to the point where those aren’t as big of concerns as they were in the past.”
In fact, over the last two quarters, LexisNexis Risk Solutions has put together a full suite of small business credit assessment products that blend three data sources (traditional small business credit scores, financial payment history, and alternative data) and are making an impression on the industry. Ben shared a case study involving one of the top five small business lenders with particularly promising results.
“They had us do a retro test (using old data to retroactively test a new process) on 500,000 applications,” he said. “What they wanted to know was, ‘Using this alternative data, would we have been able to increase our approval rates?’ What we see, in these 500,000 applications, just using the credit data alone, only about 35% of applicants had a traditional credit history or has built a credit score.”
With only a 35% hit rate for traditional credit data, you’re left with thousands of applicants who could end up being risky bets — or could be missed opportunities. For card issuers, the missed opportunities are of particular interest, said Ben, because the first lender to bring in a customer will garner a larger wallet share and a more loyal customer.
“We applied the alternative data and our score, and that took the [identification] hit rate from about 35% — up to over 80%. A huge increase in just the percentage points of the number of individuals we could identify,” described Ben. “Of course, just because we could identify them doesn’t mean that they’re all willing to repay, able to repay, and reputable.” The LexisNexis Risk Solutions team analyzed that 80% of applicants using traditional credit data and its alternative data to score each applicant.
“We found one out of three looked like they’d be a good bet, based on our alternative data credit score,” Ben said. “We were able to go from about a 20% approval rate using just the credit histories, to about a 30% approval rate using the credit history and that alternative data — so about a 50% increase in approvals.”
Changing How Lenders Manage Small Business Accounts
In addition to increasing the number of small business credit applicants who can not only be properly identified but accurately assessed for risk, LexisNexis Risk Solutions has been developing a better way for lenders to manage all of those new approvals through its new account monitoring solution.
“After you book a small business customer, a lot of things change. Things as basic as economic situations can change, management can change; regulations are always evolving. Many things are going on after you book the customer; it’s not a one-and-done type of deal,” Ben explained. “With small business monitoring, we’re proactively looking at some of the key changes that could happen in a small business and result in an issue — or an opportunity — with the lender.”
To do that, LexisNexis Risk Solutions created an automated product that looks at the activities of a small business using the same types of data as it does when doing an initial risk assessment. They see if the business has opened new accounts with other lenders, if it has delinquencies or charge-offs, changes in credit score, and more.
“The goal is to give the lender, proactively, a view into what’s happened to the business,” said Ben. “If it’s a negative, they can reduce or even eliminate some of the unused credit. They can proactively contact the customer in the early stage of a delinquency, set up a payment program; some type of workout, some way to reduce the risk of default. On the positive side, if they’re seeing positive indicators, they can reach out and try to upsell additional services.”
The Global Impact of LexisNexis Risk Solutions
According to the Small Business Association, more than 28 million small business are operating in the US alone — and they account for 54% of all US sales. Furthermore, the number of small businesses in the US has increased by a full 49% over the last 25 years. Of those millions of small businesses, only about a third have a traditional thick-file credit history, meaning millions of applicants are left on the cutting room floor when put through traditional credit risk models.
“We haven’t aggregated the non-US data sources yet,” he said. “Some of the same core issues are there. “Are you creditworthy? Are you a legitimate entity? Should I be monitoring you? The core data linking applies to non-US business, but it comes down to data. The world’s a big place, so we’re taking on the US first, and looking at some additional jurisdictions as we go.”