Financial technology company hopes to boost small business loans

“We allow the bank on the edge to basically find a way to say yes,” Joe Beard, the start-up’s co-founder and CEO, told me on the sidelines of the SXSW Interactive Technology Conference in Austin. “The way that we do that is we will provide collateral coverage.”

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When business owners apply for a loan, they typically have a plan for how to use every penny. Many times, though, when the loan officer plugs the numbers into their underwriting system, the borrower doesn’t meet the criteria to get what they need for their plan.

Maybe they’re a new business without a track record, or the entrepreneur doesn’t have enough personal assets.

The problem has gotten worse since the Great Recession of 2008. Congress passed the Dodd-Frank Act to tighten lending standards to avoid another crisis caused by sub-prime borrowers.

Small commercial and industrial loans have fallen by more than 9 percent at large banks and by even more at smaller banks, according to the National Bureau of Economic Research, a non-profit research group. Since businesses are built on loans and lines of credit, Dodd-Frank has hurt local economies.

“These financial reform acts have significantly contributed to increasing the fixed costs of starting firms, thereby slowing the pace of business formation in the U.S.,” the NBER study concluded.

Small and medium-sized businesses have resorted to other sources of capital, such as non-bank lenders that charge high-interest rates and fees. Community banks, which make significant revenue on small business loans, also suffer because they attract fewer business customers, who also open checking accounts and pay fees for other services.

Beard noticed the problem while working for Perot Jain, an early-stage venture capital firm in Dallas, where he led investments in more than 45 companies. As a West Point graduate and African American, Beard also noticed that historically under-represented business people such as minorities, women and veterans struggled the most.

“One of the things that I learned over that time is that if you have a good entrepreneur, with the work ethic, the intelligence, the grit; and if you can help them get efficient access to capital, they’re gonna go change the world,” he said. “They’re gonna hire people. They’re gonna build great products. They’re gonna provide great services, and that’s all a benefit to the community.”

Beard’s team at Collateral Edge developed an algorithm and a computer application that integrates into a bank’s existing workflow for examining and approving business loans. He said his company meets with banks, analyzes their loan criteria and then integrates the app into their system.

If a loan officer is working through the loan and discovers that a borrower does not meet the bank’s criteria for the total amount requested, the officer can click on the app and see if the borrower meets Collateral Edge’s criteria.

Collateral Edge’s cloud computing system uses a proprietary algorithm to make a risk calculation using 60 data points in addition to using financial data from Moody’s rating service. Within seconds, the app lets the loan officer know if Collateral Edge will put up the extra collateral and the annual fee to secure it.

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Banks can pay the fee or pass it on to the borrower. Beard is confident Collateral Edge’s algorithm makes the right decision most of the time. The bank then gets to provide the loan and collect interest, while the small business gets to execute its complete plan.

After the first year, the bank can either release the collateral or renew it with another fee. Providing more loans also helps the bank with another federal law. The Community Reinvestment Act requires banks to invest a certain amount in their community.

“Not only can we help this generation of entrepreneurs, but if kids in college right now see an easier, better pathway to access capital, then maybe there is somebody who is contemplating being an entrepreneur, instead of going to be an accountant, and maybe that person gets the confidence to stretch and try to build something amazing,” Beard said.

Sometimes all a small business needs is a bit of strategic help. As financial technology becomes more sophisticated, companies like Collateral Edge can make a big difference.

Chris Tomlinson writes commentary about business, economics and politics.

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