Although the list of SME financiers (financiers of small and medium-sized enterprises) is long and includes both banks and start-ups, they have a hard time with fast-growing e-commerce companies. Firstly, potential borrowers rarely meet standard criteria in terms of company age and/ or profitability. Secondly, their borrower-based risk models bring challenges that make it very difficult to serve this group of customers economically. We will take a closer look at three problems and show what advantages a product-based approach offers.
The standard mode of customer acquisition is marketing. However, conversion rates in Germany, for instance, are notoriously poor, as debt capital is often misunderstood as a sign of a weak company (we will highlight the advantages of debt capital in a separate blog post). In addition to poor conversion, as a lender you face adverse selection. In other words, the potential customers that first respond to your advertisement are the ones that are least creditworthy from a classic borrower-based perspective. Besides, wasting precious marketing spend, it also leads to lost opportunities and post-processing costs.
With product-based financing, on the other hand, marketing measures can be directed much more specifically at merchants with products that can be financed. Being able to target customers with a suitable product portfolio leads to higher conversion of your marketing efforts, avoids adverse selection and ultimately also lower default rates.
In a borrower-centric risk model, the credit decision is based on historical data. Even in a current loan, updated data is only available with a time lag. Thus, a loan cannot be monitored in real time resulting in reactive as opposed to proactive risk management. In most cases, it is only possible to react when it is already too late. To counteract this, borrower-based financiers often work with periodic repayment plans. However, these are not aligned with merchants' cash flow profiles that are not as linear as fixed periodic payment plans.
Product-based financing, on the contrary, makes it possible to continuously monitor the risk position and take proactive measures. Through the transparency of product data, changes in the competitive situation and/or general erosion of prices can be anticipated. This way, Myos can react early when the loan to value (i.e. the money lent vs the market value of the collateral) deteriorates. The borrower must then, for example, repay a part of the loan or provide further collateral. In the financial world, this readjustment mechanism is also known as a "margin call".
A third challenge for trust-based risk models are the traditionally low recovery rates. Usually, SME lenders rely on guarantees backed by personal assets. In the early years merchants typically have limited personal assets, and even if they obtain more over time, they are usually strongly interwoven with the company's success. The enforcement process is very complex and therefore, long and expensive. For example, some financiers have a default rate of up to 7% after enforcement and take 3 years to recover 49% of a non-performing loan (Source: Funding Circle, 2021).
In Myos' product-based financing, on the other hand, the goods held in inventory serve as collateral - collateral in the form of a personal guarantee is not necessary. Where required, these goods are sold to recover a non-performing loan. As a result, Myos, in contrast to classic lenders, has a much lower default rate of 1% after liquidation of the collateral and a recovery rate of 75% after only one year.
Expert opinion: "Classical risk approaches fail in the e-commerce segment mainly due to sometimes horrendous costs for the acquisition of new customers, reactive risk management and low recovery rates. To solve this challenge, one has to start at the core of lending, the risk model. By the way, this is not only true in the e-commerce segment, but is a fundamental problem: the "one-size-fits-all approach" is undifferentiated and not up to date. Default risks and recovery success are too business model-specific to serve everyone with the same approach."