SME funding gap driving demand for technology to turbocharge lending

There is a significant worldwide funding gap for small and medium enterprise (SME) working capital needs owing to a mismatch between the size of loans needed by SMEs and the cost associated with traditional banks’ lending practice that prevents banks from recouping the cost of extending credit with associated interest income and fees.

We think both public policy and private sector innovation will increasingly look to Lending-as-a-Service (LaaS) companies — companies that use technology combined with existing and new data sources to reduce the cost and risk of lending to SMEs and thereby expand the supply of funding – as a key to filling the SME funding gap.

We estimate the U.S. LaaS total addressable market (TAM) at $1.2-2.0 billion with only 3-4% penetration. We expect the TAM to grow at an 18% annual rate driven by growth in factoring loans and venture capital funding, normalized GDP growth of about 2% annually, an expectation of higher demand for SME credit following the exhaustion of Paycheck Protection Program (PPP) loan funds, and further progress toward open banking in the United States.

We expect penetration of the TAM to increase by 35% annually, reflecting the 18% TAM growth plus increasing adoption of LaaS technology by capital providers seeking to address the growing SME funding opportunity more efficiently. This mirrors trends in the EU following the adoption of open banking.

We discuss 27 providers aiming to transform SME lending with innovative technologies and data.

On April 21, as Treasury Secretary Steven Mnuchin announced an incremental $310 billion in emergency PPP forgivable loans for small businesses hit by the COVID-19 pandemic, he proclaimed it was critical to extend a total of $600 billion in funding to small businesses, which are the “backbone of the economy” and “50 percent of the private payroll.”

The reality is that even prior to the COVID-19 liquidity crunch that small businesses currently face, there was a significant worldwide funding gap for SME working capital owing to a mismatch between the size of loans needed by SMEs (and lenders’ potential profit from those loans) and the cost associated with traditional banks’ lending practices that prevents banks from recouping the cost of extending credit with associated interest income and fees.