How Blockchain May Solve The Small Business Funding Crisis

FinTech, Innovation, Investing | December 4, 2018 By:

Small and medium-sized enterprises (SMEs) face numerous challenges in the current business environment. While these companies form the backbone of most major economies, they face high barriers to entry and minimal protection from issues that larger competitors wouldn’t flinch at. Smaller firms are unlikely to have the collateral or audited financial statements that would support their loan applications; nor do they tend to have established relationships with banks.

Inherently risk averse, banks’ tolerance for SME lending is relatively low. That situation has only worsened since the 2008 financial crisis, with bank credit constraints tightening – only easing slightly over the last few years.

Inability to raise capital continues to cause enormous harm to small businesses – hurting their ability to scale and purchase additional assets, services, and inventory. Ultimately, it impacts their ability to stay in business: companies identify the lack of working capital as a major reason for corporate failure, second only to the lack of market demand for their products or services.

Some 70% of small business would rather forgo growth than borrow. That’s because even though most small businesses can hypothetically successfully secure loans through banks, they don’t always want to: they’re often left with unfavourable interest rates that can be crippling. At a time when businesses are supposed to be undergoing rapid growth, a small but not insignificant portion of revenue has to be dedicated to servicing debt.

Crowdfunding has come in to fill the gap in the market, but it comes with a number of disadvantages. Most existing equity crowdfunding platforms focus solely on start-ups or early stage businesses in specific sectors (in particular technology and brewing), meaning that this new funding route is closed to most SMEs from other sectors. The majority of platforms also limit investor reach, resulting in incomplete raises and wasted potential.

In terms of investor risk, crowdfunding is also problematic. Regulators rarely require crowdfunding websites to review opportunities and fact-checking the entrepreneurs’ claims. Investors throw money at businesses that have had little – or even no – income whatsoever, with a far higher risk of failure, and with little prospect of getting any money back if the business fails.

P2P blockchain funding – what’s the deal?

P2P equity represents the most promising lending format of the future, particularly with the advent of blockchain, for which use-cases go far beyond cryptocurrency. The decentralized nature of blockchain circumvents the need for an intermediary, an attribute which could help revive peer-to-peer lending practices – digitizing what was once a manual process.

The business fundraising process has traditionally been a complicated one, dominated by a handful of powerful banks. But blockchain’s self-reliant data infrastructure – its smart contracts – naturally connect all parties on a system, so the customer would be linked directly to investors, with full transparency, and a real-time view of finances on an immutable ledger. Through disintermediation, blockchain makes it significantly easier and faster for small and medium-sized companies – not just technology start-ups – to raise funds through equity.

The removal of these barriers reduces the need for complicated paperwork that has previously precluded many SMEs from engaging with banks. The automated nature of the whole process means that commissions, excessive brokerage fees associated with selling shares, and other overheads can all be slashed. Since smart contract agreements are irrefutable and enforceable, there’s no great need for third-party legal advice.

Importantly, the use of blockchain enables SMEs to sidestep the banks which, especially following the 2008 crash, have been acting more conservatively. Blockchain also opens up businesses to investors from all over the world, enabling both investors and start-ups to seize opportunities which had previously been closed to them.

What’s next for blockchain funding?

The inefficient and antiquated system of bank business loans is ripe for disruption, and blockchain seems to fit the bill. As mainstream banks become a smaller part of the market for small and medium-sized enterprise lending, and as start-ups are looking to pursue alternative finance rather than traditional debt funding through banks, blockchain funding systems looks set to mushroom in value.

With blockchain, comes cheaper, more competitive, and more available financing; this, needless to say, is all great news for SMEs.