Today, many small businesses act like banks. Many business owners would never choose to act like banks if they felt they had a choice, and they certainly don’t reap the benefits that banks do. Yet, there they are, extending credit terms left and right. We’re talking about the practice of offering Net-30/60/90 payment terms: a system sometimes called trade credit, or simply, Net terms.
These are pervasive practices among small businesses selling or buying from other businesses (also called SMB2Bs), a market that’s estimated to reach $4.5 trillion dollars in transactional volume in the U.S. by 2020. While many businesses may feel resigned to the status quo, there is a better way.
How Businesses Are Forced to Act Like Banks
Trade credit is used by 60% of small businesses in the U.S., making it the second most popular financing option after that of traditional financial institutions. Often, offering credit makes sense: Sellers offering credit facilitate more sales by allowing customers to make purchases even when they don't have cash on hand. This flexibility encourages customers to make more purchases, which is good news for vendors.
Of course, there are trade-offs for business owners: Buyers appreciate the time to pay, but their invoice is still due in full at the end of the Net terms; they often can’t finance it over time. On the seller side, extending credit means taking big cash flow risks of your own. U.S. B2B businesses often have cash outstanding for a longer period than they have cash on hand.
This informal credit system deeply affects the small business economy. As long as SMB2B transactions run on Net-anything, goods and services leave businesses before money comes in, creating cash flow crunches up and down supply chains.
How did SMB2Bs get here?
The cash-flow crises that stunt SMB2B commerce are not unique to B2B. B2C commerce had this same problem but solved it. In fact, it’s been solved so well that we take it for granted. Every time you or I swipe a credit card, we get instant “net terms” and financing. That purchase goes on our monthly statement, and we can pay it off over time. At the same time, the merchant gets paid right away.
As recently as the 1950s, B2C businesses kept careful track of their accounts receivable, extending credit to customers and maintaining paper IOUs. Then credit cards appeared, offering a win-win: Cardholders could pay with credit, and merchants got paid right away (with a transaction fee). Moreover, card issuers assured businesses that cardholders would buy more and promised cardholders convenience -- a card with one monthly bill -- and a status symbol to keep in their pockets.
The world of B2C payments never looked back.
However, this transformative solution has scarcely affected B2B. Even today, over half of B2B transactions happen on checks, not credit cards. By comparison, consumers prefer credit cards over any other payment method. The discrepancy boils down to two differences between B2B and B2C transactions.
First, it’s harder to underwrite small businesses than it is to underwrite consumers, making it harder for businesses to access credit. In a recent survey, 27% of businesses reported that they were not able to find the funding they needed.
Second, the average small business must contend with many regular expenses, including frequent large outlays. Credit card limits and processing fees become prohibitive, especially in certain parts of SMB2B supply chains where businesses support razor-thin margins.
The credit card solution of the 20th century specifically works for businesses and consumers, not businesses and other businesses. Small businesses need their own 21st-century network that achieve the same ends as a credit card but built for businesses.
The Future Of Frictionless Transactions
SMB2B commerce needs what B2C has -- a way for sellers to get paid at the moment of sale while buyers purchase with credit -- but needs credit underwriting and payment tools suited to businesses’ unique needs. Unfortunately, until recently, there hasn’t been anyone able to champion building a new B2B infrastructure.
Recent advances in artificial intelligence (AI) and big data analytics indicate that B2Bs shouldn’t have to live like this much longer. Now that nontraditional fintech lenders are able to leverage AI and machine learning to process the explosion of data around business transactions in order to make better, faster lending decisions, the way we understand the B2B credit and payment ecosystem can finally evolve.
There are a few elements that are making this transition possible. First, as SMBs accelerate their adoption of cloud services, such as online banking and invoicing, it becomes easier for more transactions to move into the cloud -- and away from cumbersome payment methods like checks. With so much data in the cloud, credit underwriting can increasingly rely on an expanding network of nontraditional data sources, meaning that transactions will become easier to underwrite based on the merits of the business (as opposed to consumer metrics like FICO scores). Finally, AI advances allow faster underwriting, enabling credit decisions and transactions to proceed within hours or even seconds.
This is the promise of not just a new SMB2B credit network but of truly “open” banking -- a term that has already become popular in Europe in reference to data accessibility: automated, accurate and cost-effective underwriting -- distributed access to service that allows SMB2B’s access to credit, capital or payments at their moment of need, and a higher quality customer experience on par with what today’s B2C customers demand.
When your lender is actually a data science technology company, able to draw meaningful insights from the multitude of transaction data produced with every sale, transactions can become frictionless, seamless and more efficient for all. The good news is that this future is not far off -- it is emerging today, here and now.
