As VCs And Traditional Banks Leave Startups Floundering, Digital Lenders Will Provide the Lifeline

Digital providers are already using live data to offer growth lending and buy-now-pay-later products

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The VC funding bubble is precipitously close to bursting, and Aussie startups are the ones on the line. Emboldened by years of rising valuations and a seemingly endless supply of cash, startups are now shedding employees in a bid to stave off a capital drought as VCs look to cut off the taps ahead of a possible recession.

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Australians—like much of the world—have been thrust into a shocking encounter with high inflation, caused by COVID, the war in Ukraine and flooding, which has seen real household disposable income fall for two years in a row. In response, the Reserve Bank continues to raise interest rates (which could go as high as 3.35 per cent, according to governor Philip Lowe) in a bid to curb these rising prices.

Rising interest rates also means that startups, funded on the premise they will one day generate earnings, have become far less valuable. The rise of billion-dollar unicorns, bolstered by venture capitalists' race to invest at any price lest they miss out on unimaginably high returns, gave hope to thousands of founders that they could be the next. Now, they are paying the price: after years of unfettered access to funds—not to mention last year's record high, which saw more money and deals pour into startups than at any other time in history—VCs are pulling back, leaving many fledgling startup founders at their wits' end and in danger of losing control of their own companies.

This gap has opened up a need for new avenues through which startups can access capital.

Banks, we know, have traditionally been reluctant to lend to new businesses, which often lack an existing credit score, consistent cash flow, collateral and other features required for underwriting. While this may appear prudent, lending capital to established companies only, means missing out on a pipeline of innovation that by its very nature, must begin with some risk.

In many ways, traditional institutions such as banks remain wedded to pre-technology, conventional business models which operate according to very different principles to most startups.

This approach means that the baseline for approval for traditional finance has remained, for the most part, profitability. And while this may not be a problem for a long established business, most startups—even the ones that go on to be hugely successful—are not profitable in the first few years, just look at Amazon.

While there is crossover between startups and small businesses, a one size fits all approach to loan decisioning is never going to work properly. Startups have specific needs regarding credit and underwriting; they also need different financial products that are fit for purpose, such as revenue-based financing or venture debt.

Startups also tend to have a higher operating spend than small businesses, so the ability to understand spending patterns and runway is vital. Understanding the business' burn rate also helps predict future changes, which indicates the ability and likelihood of repayment.

If they're not yet turning a profit, external funding (such as venture capital or equity crowdfunding) could be temporarily bankrolling customer acquisition or potentially the means of repaying any loans. This is something that must be considered when underwriting startups.

Realistically, however, the current economy will offer more pain before it stabilises. Globally, the Chair of US Federal Reserve Jerome Powell says the economy will endure some distress to curb inflation. In Australia, Treasurer Jim Chalmers announced in his economic statement that Australia's inflation will peak at an annual rate of 7.75 per cent by the December quarter of 2022 and fall gradually, allowing wage growth to begin providing workers with real salary increases by the 2023-24 fiscal year.

While it's not doom and gloom for all startups, with many left with plenty of cash in the bank following last year's capital raising boom, uncertainty about when capital will next be freely available and on what terms has resulted in caution.

We know that major financial institutions have never been particularly friendly towards the startup sector—but technology has, and it can be when it comes to providing some cash relief, too.

One way to overcome this inbuilt disinclination from major lenders (and increasingly smaller lenders and VCs) is to find a way to take into account a range of factors—not just the credit score and publicly filed accounts—which illustrate the financial viability of a startup.

While a tumultuous economy and rising interest rates and inflation are understandably turning traditional financial actors more risk-averse, technology can actually help lenders get a clearer understanding of the businesses' recurring revenue and key customer metrics.

Most startups use various financial platforms to help run their business. Pulling real-time data from accounting, commerce and PoS tools, as well as bank accounts, can provide genuine insight into their financial performance. It can provide far more comprehensive business insights such as who the startup trades with and how often, average invoice value, incomplete or bounced payments, and even funds directed to risky endeavours.

Digital providers like Crowdz and Cloudfloat are already using live data like this to offer growth lending and buy now pay later products—a way of offering smaller chunks of non-dilutive capital for a specific purpose.

By doing this, providers have a better chance of profitably when lending to startups during an economic downturn, but it won't be plain sailing. Many of these newer providers don't have their own balance sheet and so have to rely on borrowing funds from the big four, in turn impacted by higher interest rates and lower rates of acceptance. To combat these challenges, there's even more reason for digital lenders to make data their edge. Willingness to think outside the box and dig deeper may just cement them as the hero of the tech history book.

One thing is clear, no longer can startups take VC or bank funding for granted. Technology has moved on and so have the ways we can judge the success of a new business. If the market monopolisers don't move soon, we can be confident that digital disruptors will.