Most credit decisions in the Small Business Market are decided on the basis of the personal credit worthiness of the owner of the business. This is due to the fact that there is very limited actual credit information on this segment of the market.
- Out of the 30 million plus businesses in the US, less than 5 million have any reliable payment history available.
- Fewer than 9 million have any standard risk scoring such as the Experian Intelliscore.
- Thus there are some 21 million small businesses without any or very limited credit information available (2/3rds of the businesses).
- The lack of available credit information is significantly worse for businesses with less than $1 million in sales. In this category only about 10 percent of the business have any payment history available.
The use of personal information for evaluating small business credit poses a number of issues for credit originators. Many financial businesses regard selling credit products to small businesses as a marginally profitable activity. This is because marketing costs are regarded to be high due to low offer response rates and the resultant high contact costs, higher credit evaluation costs due to marginally useful information from the credit bureaus, relatively lower product usage rates and the potential for higher default rates. These elements are true primarily due to the following:
- Personal credit information can only be employed after the applicant has applied for credit and not for marketing purposes. From a marketing standpoint, most direct credit marketers mail only those cases which have some credit information and which have better risk ratings within the limited credit information sphere. Thus, marketers continually contact some 3-5 million businesses for credit offers greatly dampening response rates. This also means that over 25 million businesses are contacted for credit products only on a sporadic basis – a great opportunity if you can identify those businesses from this group with acceptable risk profiles.
- A number of major industry studies confirm that on average 20% of a small business’s performance is explained by management’s abilities and 80% from economic, market, and competitive factors. The present risk evaluation methods are not necessarily predictive of the future, for they rely predominantly on very limited past payment history, and usually for logistics or utilities – not industry suppliers.
Most small businesses are captives of their immediate market areas. They can’t grow faster than the norm because competitors would soon step into such a market. If they grow slower than the average for their industry their businesses will suffer cash flow problems.
The impact of economic conditions within the local market is generally a better gauge of how companies will pay their bills in the future. If economic conditions are worsening then retailers and service industries will feel the impacts first followed in time by suppliers to these industries. Examination of personal credit histories does not generally reflect future economic conditions except after the fact.