Exclusive: ‘The moment that matters’ – David McHenry, Silicon Valley Bank and Peter Lord, Codat in “The Paytech Magazine”

Open finance has been a way of offering sinking SMEs much-needed ballast during the COVID crisis, according to Silicon Valley Bank’s David McHenry, and Codat’s Peter Lord – and now it’s here to stay

Earlier this month, DoorDash and Airbnb floated on the stock market with all the confidence and serenity of a cruise liner pushing free of its moorings for the first time. That their initial public offering (IPO)-exceeding splashes took place above the wrecks of millions of SMEs will have stung those small business owners whose firms have been terminally torpedoed by the coronavirus crisis.

The cemetery of submerged SMEs looks set to grow in 2021. According to a survey conducted by Alignable, just 43 per cent of small business owners believe they’ll survive through to June 2021. Another survey, this time from SME experts Fundera, found that only 48 per cent of small businesses currently have their financing needs met. However you choose to slice it, the prognosis for half of the world’s SMEs is as gloomy as it gets.

SME failure is shaping up to become a pressing problem. In the UK, some 5.8 million SMEs contribute £2.2trillion, or  52 per cent, towards the country’s gross domestic product (GDP). They also account for 44 per cent of the nation’s employment. More importantly, SMEs drive the profits of buoyant big businesses. DoorDash and Amazon are built upon SMEs; without them, they’d have no food to deliver, and no products to list online. Repairing holes blasted in the hulls of SMEs in 2021 will be an economic imperative, not a romantic effort to revive much-loved local stores.

Any SME rescue package will focus on improved access to capital. In ordinary market conditions, funding issues are the primary reason SMEs cease trading. Now, Fundera reports that 87 per cent of SME owners say they need additional funds to survive – with 60 per cent admitting that need is ‘critical’. The problem is, only 63 per cent of UK bank loan applications are successful. Lending appetites are at their lowest levels since 2008, driven largely by tentative and outdated legacy institutions.

The solution, in the eyes of fintech thought leaders, is open finance. The free flow of financial data between SMEs and the financial institutions they use to bank, borrow, save and invest. Larger reservoirs of data, the wisdom goes, offer real-time financial insights and quicker, more responsive loans.

For David McHenry, who heads up global treasury and payments advisory in the EMEA for Silicon Valley Bank (SVB), the pandemic has been a watershed moment for such initiatives.

“COVID has been this inflection point that’s driven innovation in so many areas – due to rapidly changing conditions, the fact teams are distributed, they’re trying to share information and they need single sources of truth,” he says.

“Open banking was already starting to crack that open, with banks freeing  up that information – now, SMEs need to make decisions quicker and take advantage of lending and working capital. Open finance has been driven to the front of the queue by COVID.”

A pivotal solution

McHenry’s bank, founded in 1983, is an expert in the innovation economy: SVB has funded more than 30,000 startups, including a whopping 69 per cent of US venture capital-backed companies with an IPO in 2019. It’s little wonder that a bank based in Silicon Valley has profited from funding US tech unicorns, though now SVB also operates from offices in the UK, the EU, and China – anywhere that cutting-edge technology is developed.

Peter Lord is CEO and co-founder of Codat, which provides the plumbing, through a single white-label application programming interface (API), that connects financial services software into one, centralised system for SMEs to make use of. Codat is open finance realised and applied. And he’s in agreement with McHenry  that the pandemic has hastened efforts to innovate in the funding space.

“The pandemic definitely changed the need for something like open finance,” Lord “Codat deals with SMEs – and we know small businesses don’t use one monolithic system; they use lots of different products and services, and want those services to be connected seamlessly,” says Lord. “And, in order to have an understanding of their financials, they need a central place where all that data can exist, connected.”

Codat is currently integrated with 65 financial institutions, including two Tier 1 banks which serve 100,000 UK SMEs. The firm reports that 15,000 new SMEs connect to Codat’s API each month, and that £2.5million in new funding fromthe UK’s BCR (Banking Competition Remedies) fund will enable Codat to  offer accounting integrations that could serve up to 90 per cent of UK SMEs.

As of November, financial institutions connected through Codat’s API had processed 20,000 emergency loans, backed by the government, to pandemic-hit UK SMEs.

Seeking a new way

Designed to offer ballast to the SME sector, the early UK loan stimulus schemes were dogged by inefficiencies and delays – and small business leaders say many SMEs are still struggling with funding rejections.

Only half of the UK SMEs that applied for a government-backed loan were successful – and, according to Censuswide, 42 per cent of those waited more than two weeks to hear back from their bank. In the US, it was revealed that big business gobbled up the majority of the $660billion earmarked to support companies through COVID – leaving SMEs short-changed.

It seems traditional lending protocols simply couldn’t handle the strain of the pandemic – especially in a post-2008 environment of de-risked portfolios and near-paranoid underwriting procedures. Many SMEs were unfairly penalised for being young, with an inadequate credit history. Others were denied coronavirus relief loans for defaults caused by the coronavirus crisis itself. Often, banks’ data on the SMEs they purport to serve was so myopic and one-dimensional that rejected loan applications were an inevitability.

No wonder half of SMEs in the UK are actively looking for alternatives: in a pivotal period for their businesses, traditional lenders failed them.

“There’s this idea of moments that matter,” says McHenry. “The idea that businesses can gain not just insight from open finance, but also solutions for certain points in time – whether it’s liquidity or  deposit options – I think that’s a big draw of open finance.”

Lord believes things have already taken a great leap forward since the first lockdown.

“Businesses have gone online and that means there is now a vast amount of data that SMEs, banks and lenders can utilise,” he says. “I think we’re seeing this open movement gather steam. We had open banking, now we’re talking about open finance, but it’s all part of a much larger open data shift.”

It’s taking place on both sides of the Atlantic, too – though, according to McHenry, it’s driven by different forces.

“Open, aggregated information is already happening in the US– but it’s not mandated or regulated – it’s happening through the players that want to be involved,” McHenry says.

“In Europe, open banking was regulation-driven. But financial institutions that want to be successful in future will adopt open finance. It will be customer-centric and driven by demand, so enterprises will have to embrace it.

“What’s really interesting, especially in the US, is that small businesses are demanding this connectivity,” adds McHenry. “That’s a big influence to make things happen in a short period of time.

“There’ll be some voting with the feet, when it comes to connectivity – and that will obviously have an impact, in terms of the financial institutions and the extent to which they want to adopt more open  operating standards,” he says.

It’s a warning shot towards incumbent lenders, many of whom are already aware of their declining reputations with SMEs. According to Reparo Finance, only 52  per cent of SMEs in the US are confident their bank would grant them a loan – down from 59 per cent last year. Data from an Accenture report, meanwhile, has found that 42 per cent of surveyed SMEs believe alternative lenders offer a better service.

As SVB will readily inform heel-dragging traditional lenders, many small businesses wind up as unicorns. Underserve this segment, Codat would argue, and you risk losing your chapter in future startup success stories – and the associated returns.

Huge opportunity

It’s unclear whether alternative lenders presently make better partners to SMEs than traditional ones.

In the UK, lendtech firms have encountered their own liquidity issues this year and the fact remains that while the approval rating of institutional lenders amongst SMEs, according to Fundera, sits at 66 per cent as of November 2020,  alternative lenders’ approval rating trails at 56.8 per cent. Whether this gap narrows and is overturned in the coming months will depend upon incumbents’ engagement with open finance –  provided by enabling firms like Codat.

A recent report from venture capital firm, Finch Capital, declared the onset of a ‘big pocket’ battle between the incumbents and their challengers, to decide who can develop the best, most-integrated digital services.

The spoils? The custom of billions of consumers and small businesses who have become more  comfortable transacting online since March.

Open finance – the productive integration of disparate data sources into one ‘single source of truth’ for consumers and SMEs – will almost certainly come to define this battle. And with surviving SMEs licking their wounds, it’s a competition that the global economy, not just the UK and US, will wish to see play out as quickly as possible.

This article was published in The Paytech Magazine #07, Page 37-38