It’s not uncommon for small businesses to default on loans or other types of financing. According to Equifax’s 2021 small business lending, delinquency, and default data, October 2020 saw the highest default rate (3%) in over a decade because of the COVID-19 pandemic. A 3% default rate may not sound like much, but given that there are 31.7 million small businesses in the U.S. and a double-digit lending approval rate, 3% can translate to tens of thousands of loan defaults per month.

Similarly, Fitch Ratings predicts that the leveraged loan default rate will stay just below 2% in 2022 and 2023. But even this seemingly low rate could amount to about $25 billion of default volume in 2022 alone.

Lending delinquency and default are common risks that every lender must accept when extending financing. So, like any enterprise, running a dedicated business financing company or a B2B lending service involves careful risk mitigation. That’s why we’ve decided to share the top five tips for minimizing lending risk with those new to the financing arena, especially companies in the process of adding a B2B financial service to their portfolio. The key to safe lending is not to do it by yourself. We'll explain how partnering with a lending service like Loanspark eliminates the lending risk completely.  

Why do SMBs default on loans?

Before we talk about managing lending risks, it’s important to understand why some small businesses might default on credit. Here are some of the common reasons why small and medium-sized business owners might have difficulty paying off their loans:

• Encountering financial distress from unexpected economic disasters such as global pandemics, recessions, and market turmoil
• Having too much debt relative to the business’s revenue and cash flow
• Not knowing how to approach the lender with concerns about repayment
• Borrowing too much or too little for the intended purpose
• Taking on a loan product whose structure doesn’t match the business’s model or financial goals
• Managing business finances poorly during the loan term

How to minimize your lending risk

Here’s how you can design your business lending products to work around most of the repayment issues we’ve just listed and lower your overall lending risk:

Target the right borrowers

Understanding your target borrowers is the first step to designing an attractive low-risk B2B lending offer. Begin by exhaustively investigating and profiling your ideal borrower — get clear answers to the following questions:

• What kind of businesses will I lend to?
• How are these businesses modeled?
• Which industry or niche do they operate in?
• How is their cash flow or revenue?
• What are their main financial pain points?
• Do they borrow from other lenders, and which financing products do they typically purchase?
• How good are they at servicing debts?

Your easiest target borrowers are your existing B2B customers. These are businesses you've engaged with before and probably know well enough to profile accurately.

Understanding who you're targeting will help you develop a product that solves your borrowers' financial pain points and brings tangible value to their businesses. And with financing products that align well with their needs, your borrowers are less likely to default.

Fine-tune your lending policies and procedures

After researching and profiling your potential borrowers, you should have a pretty good idea of what they expect when it comes to financing and the types of products they’d comfortably purchase. With that in mind, draft your lending policies and procedures to align with the borrowers’ expectations and risk factors.

However, this can be a tricky balancing act to pull off. On the one hand, you want a financing product that checks all the borrower's boxes; on the other hand, you don’t want to be too lenient and create a wide margin for risk. For instance, offering fast-approval loans (a favorite among SMBs) means you may not have enough time to scrutinize each borrower closely. Also, some borrowers might take advantage of the fast approval to stack loans, which then become difficult to repay.

Fine-tuning your lending product's policies, terms, and procedures means finding the sweet spot between risk and leniency. Set the bar at just the right height to attract borrowers and safeguard your lending initiative at the same time.

Be flexible with your lending strategy

Lending flexibility is one of the main reasons many small business owners prefer alternative lenders to large banks and commercial institutions. Even when targeting a homogenous group of borrowers, it's still essential to provide some variety in your lending options. While some entrepreneurs might prefer more conventional financing, such as loans or lines of credit, others might be in the market for products that are more specific to their needs or business.

In addition to standard SMB loans and lines of credit, consider offering varied funding alternatives such as asset financing, invoice factoring, merchant cash advances, and business credit cards to cater to those looking for more customized solutions. Limiting your offerings to just one product sort of forces all borrowers to take that product, which might not necessarily be the right financing for some of them. And remember, making the wrong financing choice can lead to default. So, the more diverse your lending offering, the more thinly spread the default risk.

Sympathize with your borrowers

Another good way to avoid defaults is by encouraging your borrowers to share any concerns they might have about repayment. The business environment can be highly unpredictable, and finances do not always add up as planned. Show your borrowers that you understand such predicaments and are prepared to negotiate a fair repayment plan if they run into a financial jam.

A loan is generally considered a “default” after six consecutive months of no payments. But you shouldn’t wait that long. Reach out to the borrower after the first few missed payments. There’s no need for stern warnings at first; just let them know they can always come to you to discuss the best way forward in such situations.

Co-brand your offering

Designing a lending product and structuring it to suit its target audience while keeping a close eye on the risk gauge is no easy task. Not to mention, you also need to develop an effective marketing strategy to get the new offering off the ground. Besides time and expertise, doing all this also requires an assortment of specialized digital tools and infrastructures that may be too costly to build and run.

If you have the time and money to become a lender, that's great. However, there is an easier, safer, and more practical way to bring a new lending product to market — co-branding.

Instead of expending valuable company time and resources on developing and launching a new lending solution, it would make more economical and logistical sense to get into a co-branded partnership with a capable Business Lending-as-a Service (BLaaS) provider.

Loanspark is on hand to help you design, structure, and optimize any number and type of SMB lending solutions for your customers. We provide you with all the financial expertise and technical resources you’ll need to deploy B2B funding products with zero overhead. We handle all the intricate lending management, from designing and building to branding the funding product. And you get to sell the product as your own.

Minimizing the lending risk hinges on making smart, informed choices right from the get-go. Launch your lending service with Loanspark by your side and enjoy a worry-free and lucrative venture into small business financing. Visit the Loanspark website to learn more about our process. Please don't hesitate to contact us if you have any questions about partnering with Loanspark.