The unique banking needs of SMBs: 5 questions with Kabbage co-founder Kathryn Petralia

The small business sector has historically been a tricky one to underwrite. It’s more complex than consumer lines, but doesn’t fall into the conventional commercial sector either.

The banking wants and needs of SMBs are different and unique – it’s all about accessing financial services tailored to their business without having to pay a huge premium for it. This demand is increasingly being met by fintechs and digital lenders that can leverage new underwriting techniques to serve more small businesses across many different industries. 

But incumbents are also waking up to the opportunity of better serving SMBs, wary of losing more market share to fintechs. There are two main options for those wanting to revamp their SMB lending products: either develop internal capabilities such as in-house tech solutions, or look externally and partner with/acquire a fintech. 

Plus, the sector is growing, so there’s plenty of room for lenders looking to add another revenue stream. 

SMBs are showing a strong recovery - In Q1 2022, the U.S. Chamber of Commerce Small Business Index recorded the highest score since the start of the pandemic, as more businesses report being in good health and comfortable with their cash flow. 

However, there are challenges as well – many small businesses report struggling with surging inflation and persistent supply chain issues. This could also be an area where the financial services industry can come in and help them weather more turbulent times. 

Some incumbents have already made some moves in this space - American Express bought small business lender Kabbage two years ago in order to expand beyond its commercial card products and get a head start in the SMB sector. Kabbage allowed small businesses to apply online and get financing in 10 minutes using machine learning algorithms.

The fintech’s co-founder Kathryn Petralia joined Tearsheet at our Convergence conference last year, where she shared her thoughts on how banks can approach the SMB sector. She is also partnering again with her Kabbage co-founder Rob Frohwein to launch Keep Financial, a platform that helps employers provide retention bonuses as forgivable loans.

Now she gave us a fresh overview of the SMB banking and lending space – what needs are specific to the SMB sector and what banks and fintechs are trying to do to meet the demand. 

How has the pandemic changed the relationship between banks and the SMB sector?

I think all banks have recognized the need to meet their customers in a digital way that they may have not been doing before. A lot of business owners are used to that daily trip to the bank, that conversation with the banker. When that was impossible, they tried to move to their mobile phones, into their apps, in order to manage their business bank accounts. And they found that they couldn't. 

A survey we conducted found that many small business owners were interested in changing their bank because of the experience they had during the pandemic. There were many reasons why businesses were unhappy with their banks, causing them to shift to other financial services providers. 

How has the fintech sector responded to the needs of SMBs?

Small businesses have generally lacked access to professional financial services. 

There are 32 million small businesses in the US – 26 million of them have no employees, and of the remaining 6 million, 90% have fewer than 20 employees and 80% have fewer than 10. Most businesses are quite small, and banks tend not to provide them with the same level of service, products and options as they do for larger businesses. 

But now there are more digital options for small businesses – there are challenger banks that have been established, big fintechs providing some of these same products and services: checking accounts, card products, expense management, lines of credit and payment processing. These are all things that are now more easily accessible digitally, to the smallest of the small businesses.

We’ve also seen the emergence of fintechs serving other sectors previously considered niche, like immigrant communities or people without credit scores for example. What do you think has propelled this fintech boom in using new technologies to bring credit in new areas of the economy?

I think it's because they realize that it is a big market and they can serve. Historically, the small business sector has not been an appealing market because it's hard to find them, but now it's getting easier. 

More importantly, technology companies are offering a full suite of services that small businesses can do in one place. It’s really important to them to have a seamless way to access many products in a single space because while they are an expert at running their business, they're not necessarily an expert in finance and financial services products. And this has only been possible because of technology. 

What are some of the biggest pain points for SMBs when it comes to banking and financial services?

Lending is an important part because lack of access to capital is one of the largest reasons that small businesses fail, so it is certainly the bedrock upon which a lot of these new products are based. 

I think checking accounts are also really important for SMBs to access funds. What we didn't know until we started building our own checking account was that small businesses, especially sole proprietors, were having to wait many days to get access to deposited funds. 

That was causing a cashflow challenge for them, and some small business owners were actually going to check cashers and paying 10% to 15% of the base amount of the check in order to get access to the funds right away. So, historically, even basic services like checking were harder to use and limited access to capital.

What are some of the challenges that you’re seeing in the SMB digital lending space?

What I find fascinating is how automation is still a challenge in this industry. At Kabbage, we got our start in automation, connecting our platform to third party data sources that our customers give us access to, in order to understand how their business was performing and their cash flow. I find it odd and surprising how people, banks, fintechs all still struggle to be comfortable with automation. 

When looking at serving the smallest of small businesses, a lot of the loan providers are only able to serve the small businesses they already serve for payments – that's the only way they can get to understand the level of risk because they're basing all of their lending decisions on the payments that are coming to that account.

In reality, many businesses get paid in many ways, not just credit cards – they may get checks in the mail, they may get paid through invoicing. There's lots of different ways that money flows in and out of a business, and a payment processor is only going to see one slice of that, leaving a lot of small businesses underserved.