This document summarizes the current state of small and medium enterprise (SME) access to capital and emerging alternatives. It finds that while bank lending to SMEs has improved since the financial crisis, it remains below pre-crisis levels due to ongoing regulatory pressures and risk aversion. To fill the resulting credit gap, online alternative finance platforms like marketplace lenders, peer-to-peer lending, and crowdfunding have grown rapidly in recent years and are expected to continue strong growth in 2015. These alternatives provide lower-cost capital options for SMEs and attractive returns for investors.

1. A Survey of SME Finance and the Emerging
Alternatives for Access to Capital
Jim Faith
Trade and Export Finance Online
Global California
December 3, 2014
© 2014 TEFO. All Rights Reserved

2. Agenda
• Section 1: An SME Snapshot View
• Section 2: Current Bank Lending Environment
• Section 3: Emerging Alternatives for SME Access to Capital
• Section 4: Alternative Finance Outlook for 2015

3. SME Working Definition and Profile
• Less than 500 employees
• Represent 99% of all American companies
• Employ over 50 percent of private sector employees (about
120 million people)
• Generate 65 percent of net new private sector jobs
• Represent over half of U.S. non-farm GDP
• Vast majority are sole proprietorships
• Represent 98% of all U.S. exporters and 34% of U.S. export
revenue
Section 1: Snapshot

4. US Small Businesses by Number of Employees
Section 1: Snapshot
Source: US Census Bureau, 2013

5. Top Five Exporting States by Number and Value
Section 1: Snapshot
Rank State Number of
Exporters
Exports
($Millions)
US 302,051 1,365,738
1 TX 40,737 279,491
2 CA 75,012 168,045
3 NY 41,028 86,523
4 LA 4,000 63,339
5 FL 61,848 61,344
Number of
Exporters
Exports
($Millions)
295,241 477,502
37,921 85,527
71,921 66,693
38,675 51,640
3,378 22,028
58,976 42,051
US Census Bureau 2013 Preliminary Report
All Exporters SME Exporters

6. Top Five Export Destinations
Section 1: Snapshot
Rank Country Value
($ Million)
1 Canada 301.6
2 Mexico 226.1
3 China 121.7
4 Japan 65.2
5 Germany 47.4
US Census Bureau 2013 Preliminary Report
Country Value
($ Million)
Mexico 23.9
Canada 18.9
China 16.3
Japan 12.7
South Korea 8.4
US Exports CA Exports

7. Top SME Exporters by Company Size
Source: US Census Bureau, 2013
Section 1: Snapshot
118K
33K
17K 14K
4K 7K
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
1-19
Employees
20-49 50-99 11-249 250-400 > 500
Top Exporters by Company Size

8. Exporters are Better Economic Performers
Exporters consistently out-perform non-exporters in:
• Higher Sales
• Higher Employment
• Pay higher wages
• Are more productive in terms of value added per worker
• Use higher levels of capital per worker
• Have higher skill intensities
• Nearly 40% of exporters also import and 80% of importers export.
Section 1: Snapshot
Source: US International Trade Commission Report (2011)

9. Current Bank Lending Environment
• Post-recession Cyclical and Structural Effects
• Regulatory Oversight: Dodd-Frank and Basel III
• The Credit Gap and Emergence of Online Alternative Funding
Section 2: Environment

10. Greater Perceived Risk Means Tighter Lending
• SME sales haven’t returned to pre-recession levels, which in turn,
means less demand for loan capital.
• Traditional collateral, primarily real estate, lost value during the crisis
making some borrowers less creditworthy.
• Banks have remained more risk averse in the recovery while focused
on integrating new regulatory oversight in their day-to-day operations.
The tighter lending criteria includes:
• Greater focus on borrower’s personal profile, credit scores, income
and assets
• Higher collateral requirements
• Increasing equity requirements for new loans
• Preference for liquid collateral, e.g. personal savings, CD’s, or
stock.
Section 2: Environment

11. Banking Industry Consolidation
• The Banking industry has been in a state of perpetual consolidation
since the mid-1980’s. Community Banks, the second leading source of
SME bank loans, are being absorbed by larger banks.
 There are less than 7,000 today, down from over 14,000 in 1984.
• Smaller banks have traditionally relied on relationship banking which
includes social context like the borrower’s character and local
community history in lending decisions.
• Relationship banking is expensive and don’t translate well to the data-
oriented criteria and automation used by larger banks.
Section 2: Environment

12. Higher Transactional Costs
• Lenders face greater risk because SME’s are inherently more sensitive to
economic volatility, have higher failure rates, and fewer assets to
collateralize.
• Publically available information on SME business and financial
performance is fragmented and costly to obtain.
• The fragmented market makes it difficult to develop general credit
standards and to securitize and sell small business loans in the secondary
market.
• This state of operational and information disconnect has yet to be
resolved and contributes to the higher transaction costs associated with
small business lending.
• Consequently, transaction costs to process a $100,000 loan are
comparable to a $1 million loan, but with less profit for lenders.
Section 2: Environment

13. High Search Costs
• The current environment includes high search costs in which it’s difficult
for qualified borrowers to find willing lenders, and lenders to find
creditworthy borrowers.
• A Federal Reserve study states SMEs can spend up to 25 hours on
paperwork for bank loans, and often apply to multiple banks.
• Even successful applicants can wait several weeks before the funds are
available.
Section 2: Environment

14. Regulatory Oversight
• Bank management has been focused on the implementation of Dodd-
Frank reforms and Basel III requirements in their processing and day-
to-day operations.
• This regulatory overhang has been an ongoing issue during the
recovery, has contributed to the lack of available funds for lending and
a case can be made that there has been a disproportionately negative
effect on SME lending in particular.
Section 2: Environment

15. Stalemate and the SME Credit Gap
• In summary, Banks say there’s a lack of demand and they’re not
finding qualified borrowers. Small business owners say that, despite
being creditworthy, banks remain unwilling to lend to them
• Transaction costs to process a $100,000 loan are comparable to a $1
million loan, but with less profit to the lender; and yet these smaller
loan amounts are generally needed most by startups and SMEs.
• The unstoppable force (small business need for capital) has met the
immovable object (bank lending) resulting in the creation of an SME
credit gap.
• And that gap is being filled by technology solutions and the
emergence of online alternative finance.
Section 2: Environment

16. Types of Alternative Finance
• Non-bank Direct Lenders
• Marketplace Lenders
• P2P Lending and Crowdfunding
• Supply Chain Finance
• Accounts Receivable Marketplace
• Merchant Cash Advance
• Equipment Leasing
• Corporate Venture Capital
• Angel Investment
• Venture Capital
• Public and Private Equity
Section 3: Alternative Finance

17. Non-bank Balance Sheet Lenders
• Balance Sheet lenders make loans and keep them on their own balance sheet
instead of packaging and selling off as securities. If the borrower defaults,
balance sheet lenders take the borrowers' assets to cover the unpaid debt.
• Typical terms are less than 9 months and the proceeds are used for working
capital.
• Repayment is made by a fixed amount or percent of sales deducted daily from
the borrower’s bank account over a period of months.
• Interest rates can range from 30% to 120% on an average loan size of $40,000.
• Preliminary market data: $5 billion in loans since 2007
• Biz2Credit
• OnDeck
• Can Capital
Section 3:Section 3: Alternative Finance

20. Marketplace Lending
• Online marketplace lending allows borrowers to comparison shop for a
range of loan products from a variety of lenders.
• Lenders can include commercial, community and regional banks and
the SBA as well as other alternative lenders.
• Mitigates the high search costs for borrowers (~25 hours).
• Revenue generated from fees paid by the borrower if they get funded.
Or the loan package is sold to a lender.
• Interest rates and loan terms are independent of the platform and
determined by the lender.
• Boefly
• Fundera
• Lendio
Section 3:Section 3: Alternative Finance

23. P2P Lending and Crowdfunding
• Peer-to-peer/Person-to-Person and Crowdfunding platforms enable individuals,
businesses, institutional investors and investment banks to lend to consumers and
businesses for specific projects.
• Platform revenue comes from origination fees deducted from the loans disbursed to
borrowers and servicing fees deducted from principal and interest payments paid to the
lender.
• Value proposition: Lower interest rates for borrowers; attractive rates of return for
investors; and a simple, web-based platform with lower operating costs than banks.
• Platform provides investors with the ability to distribute risk among multiple borrowers.
• Interest rates can range from 8% to 25% for loans up to $250,000 over three years.
• Preliminary market data: $4 billion in loans to date
• Lending Club
• Prosper.com
• Funding Circle
Section 3:Section 3: Alternative Finance

27. Outlook for 2015
• Bank lending to SMEs has improved, but has not and likely will not
return to pre-crisis levels.
 In June 2013, bank portfolio loan balances of $1 million or less was
$288 billion – down $47 billion from June 2008.
• Online alternative finance is currently generating about $10 billion in
outstanding loan capital and these alternatives will continue strong
growth in 2015. The outstanding portfolio balance of online alternative
lenders is doubling every year.
• By contrast, outstanding loan capital held by the banking sector is
declining an average of 3% annually.
Section 4: Outlook for 2015

28. Some Perspective on Alternative Finance
Section 4: Outlook for 2015
700
175 140
90 75
25 10
0
100
200
300
400
500
600
700
800
Bank Loans Business
Credit Card
Equipment
Leasing
SBA Factoring MCA Online
Alternatives
Total SME Debt Capital Outstanding as of 2013 ($ Billions)
Source: Mills, Karen and Brayden McCarthy. “State of Small Business Lending: Credit Access During the Recovery
and How Technology May Change the Game.” Harvard Business School. July 2014.

29. SME Exporters
• There are reasons for optimism – a 2013 NSBA/SBEA survey shows
that 60% of non-exporters are interested in exporting and 52% of
current exporters report increased export sales since 2010.
• A 2012 Boston Consulting Group report forecasts that by 2020,
declining energy costs and increasingly competitive wages will give
America as large as a 25 percent export cost advantage over major
exporting competitors like Japan and Germany.
• The BCG report estimates that the US will experience a manufacturing
renaissance and re-shoring starting in 2015, and could add 2-3 million
jobs and $100 billion in annual GDP.
Section 4: Outlook for 2015

30. Online Marketplaces
• Strong growth will continue in 2105. Currently Online platform
providers generally use proprietary technologies to evaluate risk and
creditworthiness. There will be increasing efforts in:
• Partnerships with third party agencies for data validation.
• Development of securitization and secondary market due to
institutional demand.
• There are credible estimates for a potential market size of $870 Billion.
This figure comes from a comparison to banks, credit cards companies
and other lending institutions that generate over $870B/year in fees
and interest over $3.2T in lending activity.
• Specialized segments will continue to grow in many areas of business
and consumer lending. Segments like real estate, mortgage appraisal,
education and healthcare etc. will continue to evolve.
Section 4: Outlook for 2015

31. Marketplace Investors
• Institutional debt and equity investors will continue to seek the
relatively high rates of return. Traditional bank loans yield 5% to 7%,
while many platforms are generating yields ranging from 30% to 120%
of the loan value.
• These higher yields are particularly attractive in the current, and
historic, environment of the Federal Reserve’s Quantitative Easing that
has kept yields low.
Section 4: Outlook for 2015

32. SME Banking
• Bank lending will likely never return to the pre-2008 environment. However
banks currently own the asset marketplace lenders want the most - millions of
SME customers accounts.
• The Bank and Credit Card industry response to online alternatives will be
interesting to watch. Some are already participating by:
• Using their capital to fund loans on marketplace platforms
• Taking a position in the platforms and offering as a value-added service.
• Assisting in the development of secondary market for trading and liquidity.
• A 2013 KPMG banking survey reports that banks have generally accounted for
the new regulatory oversight and are now placing a renewed emphasis on a
customer-centric business model and improvements to customer’s technology
experience, which in turn, will drive major investments over the next few
years.
Section 4: Outlook for 2015

33. Big Data
• There will continue to be strong growth in the use of Big Data and
development of scoring algorithms which integrate social data from, for
example, blogs, product and business reviews and tweets. Online platforms
generally recognize that integrating new sources of data is their competitive
advantage.
• The key predictive goal is to establish a correlation with repayment. The more
predictive the loan pool, the stronger the underwriting .
• A marketplace lender uses its own data in a feedback loop that increases the
accuracy of its model.
• Loan performance data feeds back into the model, further increasing the
accuracy.
• As the accuracy increases, the lender can offer lower rates to borrowers.
• As rates decrease, more borrowers come to the platform, driving more
data into the model.
Section 4: Outlook for 2015

34. Regulatory Oversight
• Marketplace lenders fall between the cracks for federal regulators because
they’re not banking entities. Currently no single federal entity has broad
authority to regulate the emerging industry.
• The majority of oversight happens at the state level, with a patchwork of
regulations within state lines.
• The P2P platforms are a hybrid of lending (the domain of regulators at the
state and federal level) and registered securities (the domain of the SEC).
• A key innovation of P2P lending is that lenders on the platform are not
lending money to borrowers in the legal or regulatory sense; rather the
lenders are investors in securities issued by the lending platforms linked
directly to specific loans originated by an underlying bank.
• These and other regulatory issues will be developed in 2015.
Section 4: Outlook for 2015

35. Regulatory Oversight
• Key regulatory and policy issues to resolve:
• Define the appropriate level of regulation?
• Transparency and Disclosure between all parties in a transaction.
• Standardized Oversight and Monitoring by Federal and State
regulators.
• Borrower financial awareness, literacy and education.
Section 4: Outlook for 2015

36. Thank You
Jim Faith
Trade and Export Finance Online
http://tefo.com
jfaith@tefo.com
831-227-0595
© 2014 TEFO. All Rights Reserved