“There is no such thing as SMEs (small and medium enterprises),” says Sashank Rishyasringa, cofounder at SMEfocused lender Capital Float. “The biggest problem with the traditional lending model has been to use a cookie-cutter model for lending to all sorts of enterprises. With SMEs, the biggest challenge is heterogeneity. There are segments and sub-segments within each different category we are expanding to, each having its unique business model.”
Capital Float, which recently gobbled up $45 million in a financing round led by Palo Alto-based Ribbit Capital, facilitates microloans to ecommerce merchants, manufacturing and supply chain partners, and other similar categories of borrowers. Over the last year, the company has pushed hard for inroads into small towns as well as to expand to microcategories such as mom-and-pop stores, hair salons, standalone restaurants, bakeries and small manufacturing units.
Lending to SMEs is inherently tough on multiple counts. Most SMEs operate in the informal economy and sourcing data on them is tough and often unreliable. New-age lending platforms like Capital Float, LendingKart, Kinara Capital and Indifi Technologies that leverage technology to originate loans and for credit assessments, sanctions and disbursals face myriad challenges.
More than 80% of their customers are micro-enterprises, mostly sole proprietorships. As these startups go deeper to find newer pockets of opportunity, sustainability will be a challenge as loan sizes get smaller and as data on borrowers are sparse.
“Execution is key. Take a cue from the credit cards business in India. If execution would have been good, this segment could have done better in India as in other economies,” says Harshvardhan Lunia, chief executive at LendingKart, which is growing at 300% year-on-year and targeting a disbursal corpus of Rs 1,500-1,600 crore by March.
Poor infrastructure and lack of touch with customers are the biggest roadblocks in reaching far-flung SMEs. “Customers sitting in Jamnagar (in Gujarat) or Kanyakumari (India’s southern tip, in Tamil Nadu) at least need to have a laptop or desktop and internet connection, which becomes a big constraint in servicing them.
Second, your solution has to be in multiple vernacular languages. We are creating an entire infrastructure on smartphones,” says Lunia of LendingKart, which recently raised Rs 50 crore debt from YES Bank. It had earlier raised $20 million over two fundraising rounds from investors including Singapore-based Sistema Asia Fund, Bertelsmann India Investment, Mayfield India, Saama Capital, and Kotak MahindraBSE -0.59 %.
Technology can no doubt be a big differentiator, especially in the most critical aspects of lending— deciding on whether to lend or not and what amount to lend—as well as to streamline costs and improve efficiencies. There are limitations to this, however. “There is no technology right now that can read all bank formats. If a borrower submits a bank document from any of the scheduled banks, there exist enough technologies to read it. But if he has an account with a co-operative bank, there are very limited technologies for that.
Differentiation can come here since over time it will be about how to lend at lower risk and lower cost,” says Vineet Rai, CEO at impact investment firm Aavishkaar.
Amid growing realization that large scale and volume are the only way to reap rewards in the lending business, startups are adopting various approaches to get reliable information. Capital Float has developed a mechanism for underwriting loans based on how a company’s cash flow is likely to evolve. It also scrutinizes a borrowing company’s payment history on point-of-sale devices, transaction volumes on ecommerce websites, purchase patterns on business-tobusiness platforms, and other pointers to an entity’s financial health. Capital Float is now going deeper to study customer behaviour by analysing data on GST filings and creating a proprietary model to understand a borrower’s attitude towards repayments, business acumen and fiscal discipline. Another big challenge is containing costs. Companies do not have a wide margin to play with when it comes to lending to SMEs. On an average, most companies borrow at 10-12% interest rate and lend at 18-19% interest rate.
The difference should cover their write-off costs (credit losses), and operating costs such as rentals and salaries, while also leaving a profit margin. “As they push for growth, companies will have to push for smaller ticket-size loans, wherein the net money companies will make per loan will be lower. So the key for all companies looking to scale will be to bring down their customer acquisition, evaluation and loanservicing costs,” says Sahil Kini, principal at Aspada Investment Advisors, an early investor in Capital Float. “Also, the smaller the loan size becomes, the more efficient collection mechanisms need to be.”
The key to success, believe industry executives, will be to work out a mix of tech and non-tech approaches. “It is easy to use the word tech and use it as a mask to raise more capital but companies need to use a combination of fintech and fintouch (human touch) as they grow,” says Ganesh Rengaswamy, partner at Quona Capital, a fintech-focused venture capital investor. One of Quona’s portfolio companies, Neogrowth, sends its executives to the offices and stores of SMEs before deciding on whether or not to advance a loan.
While technology can handle challenges such as estimating a company’s income based on cash flows and optimising operating costs, one major area where tech has not worked well yet is in collecting loan repayments.
“For most companies, collection costs remain very high and fintech companies have to give serious thought to that,” says Sanjay Sharma, managing director at Aye Finance, which provides financial services to micro and small businesses.
“Collections cannot be taken over by an automated bot. The biggest challenge here is to have a field collection force that, among other things, can demonstrate the fact that we are serious about getting payments back.” The flipside, however, is that investing in collection teams pushes up costs.
Some companies are attempting a hybrid model as they reach out to newer segments of microenterprises in small towns. “We use significant feet on street for borrowers’ education, empowering them with 4G smartphones.
However, we leverage on the expertise of people who have worked in the microfinance industry when we enter a new segment,” says Rishyasringa of Capital Float, which has kept nonperforming assets, or bad loans, as a percentage of gross loans at less than 2% even in difficult segments.
The startup plans to expand operations to 50 more cities in India, from 350 cities it is in now, and add 5,000 borrowers every month. Capital Float also aims to disburse Rs 5,000 crore by the end of this fiscal year, and until October had already advanced Rs 1,500 crore.
Credit evaluation—a critical area that determines a company’s credit risks—also needs human intervention. For Vistaar Finance, which caters to borrowers such as small hotels, bakeries and powerlooms, its biggest differentiation is its credit methodology, which is basically an offline approach to evaluating customers. “In the last 3-4 years, we have moved everything, including lead-origination and fulfilment, to a tech platform. The only thing that is still physical is credit evaluation,” says Brahmanand Hegde, CEO at Vistaar Finance, which earlier this year raised $18 million in debt funding from Reliance Mutual Funds.
Vistaar’s credit methodology studies each SME sub-sector to get an in-depth understanding of their workings as well as source more information on potential borrowers. Consider a corner store that neither keeps records of purchases from local distributors nor issues bills to customers. The storekeeper, however, maintains a record of income in a small notebook, which can be an important source of credit evaluation.
Vistar has developed a template to list all categories of products as well as the margins a store makes on each product even with such basic information.
Its credit managers evaluate customers based on this information. It will be a question of efficiency management as companies gear up to scale.
“Focusing only on growing the quantum of disbursements without maintaining a strict control on credit risks and operational costs will backfire. It is critical to keep NPA levels below 3%, credit losses below 2%, and operational costs at around 4% if you plan to scale up,” says Hegde of Vistaar Finance, which is targeting disbursals of Rs 75-80 crore a month from Rs 40-50 lakh a month now.
The microfinance in India took 30 years to take off after various trials and errors. So will it be for SME lending, say industry experts. “Financial businesses are built over 20-30 years,” says Gopal Jain, managing director at private equity firm Gaja Capital. “Kinara (a company Gaja recently invested in) is a 5-year business. In another 5 years, it will still be a young company.”
The good thing is that the SME lending space is seeing sustained interest from all ilks of investors, including mainstream venture capital firms such as SAIF Partners and Sequoia Capital as well as impact investment organisations and overseas funds. About a dozen SME-loans focussed companies have raised a total of $162.4 million in funding since October 2015, according to research firm Tracxn.
“The sector is still in its infancy on the scaling-up front, although it has generated a much higher level of interest from investors at a much earlier level of maturity as compared to the interest in microfinance (between 2005 and 2008),” says Rai of Aavishkaar. “The opportunity is huge in this space but the challenge is that we do not have a perfect answer to how do we capture value, sustainably keep defaults low, and make a healthy net interest margin.”