The Future of SMB Banking Part III: How We Get There

In Parts I and II of this series, we discussed the challenges that SMBs face and spent time exploring what the SMB banking stack of the future may look like. In order to realize the potential future of SMB banking contemplated in this series, banks will need to prioritize strategies that deliver products closely aligned with the needs of SMB customers.

Today’s landscape is seeing fintechs and incumbent tech companies move into the SMB space just as SMB-focused neobanks like Rho, Mercury, and Hatch are beginning to offer what increasingly resemble full-stack banking services. Although these developments introduce a natural competitive tension, we actually see this as generally positive for banks. We point to three key tailwinds that banks can capitalize on as they work to enhance their SMB offerings:

As banks across the country refine their SMB strategies, the most successful banks will be those that leverage these tailwinds to optimal effect; in the coming sections we’ll provide our thoughts on what that might look like.

Becoming the Financial Hub for SMBs

In Part II of this series, we introduced the idea of a “command center” that gives SMBs an accurate view of their business and the ability to conduct scenario modeling and forecasting with confidence. We believe the command center will be the central component of the SMB product suite, as well as a crucial tool for better understanding SMB customers.

The command center is built on integrations into business applications leveraging open APIs. By connecting to accounting apps like Quickbooks, payroll apps like Gusto, expense apps like Expensify, and other commonly used services, banks can offer SMBs a consolidated view of their businesses. There are three paths to launching the command center; each comes with its own considerations and will require a different amount of capital and engineering investment.

The first path is, in our opinion, likely to be least efficient. Although open APIs have gone a long way toward making real-time data connections easier, it is still a time-intensive process to build any type of direct integration. While banks may be able to avoid paying a vendor by pursuing the first path, the amount of engineering time invested will likely outweigh the cost of building on top of existing data aggregators.

The second path is for banks to partner with data aggregators who have already built integrations then build their own customized interfaces on top of those integrations. This can be a highly attractive option for banks that have strong engineering teams and the desire to build bespoke solutions.

Several companies have emerged in the space to offer secure, efficient, and reliable connections into top business applications. In particular, Codat and Railz have been pioneers in building Plaid-like integrations for accounting and financial applications. By partnering with providers like these, banks can skip the tedious process of building their own integrations and instead focus on refining and combining SMB data to build out the interfaces SMBs will come to expect. There are real benefits to building bespoke interfaces, but this method will require significant investment from the bank before being customer ready.

The final option is to work with a vendor that offers a fully white-labeled solution. upSWOT – with integrations to 120+ of the top business applications – leads the way in this approach, though Autobooks, Monit, and others also offer compelling solutions. Partnering with vendors like these will help banks get their product to market quickly and allow them to start delivering value to their SMB customers immediately.

Beyond the luxury of quick deployment, the third path offers the benefit of a wider data set to drive insights and advice. Rather than building machine learning models based solely on the data of their own customers, banks that partner with data analysis vendors will have access to the insights and trends these platforms learn from SMBs across their entire customer base. The key drawback of this path is that these solutions are often less customizable out-of-the-box, however, we believe that they can be a compelling option for banks that don’t want to spend (or don‘t have) the resources to build their own products from scratch.

Regardless which path banks choose to pursue, the command center will only be as valuable as the data that goes into it. To that end, it will be crucial that banks track adoption (how many SMB customers are linking apps) and penetration (how many apps customers are linking). Relationship managers (RMs) will play a central role in this initial stage. The best RMs will be product evangelists and take the time to educate their customers on the benefits of the command center and be diligent about answering the (likely many!) questions that SMBs will have as these products are rolled out.

Rethinking SMB Lending

With the command center built out, banks will next need to rethink their SMB lending process. We believe there are three key areas where banks should focus their attention:

As banks use their new data connections to better understand their SMB customers, they will unlock an opportunity to offer targeted, proactive suggestions for their customers’ capital needs.

Some of these will be obvious: an upcoming cash shortage may trigger an RM to offer a line of credit; an improved credit score may provide a natural opportunity to refinance an existing facility from another institution. But the best banks will go a level deeper: imagine that a successful Amazon product will soon be out of stock – RMs can offer a short-term facility to replenish the stock. This is just one example, but the possibilities are sky-high. The more data that banks have access to, the better they’ll be able to offer proactive, targeted financing options that optimize business operations for SMBs. The best part? Because banks will already have access to the SMBs’ financials, they’ll be able to provide offers with rates and terms before even being asked.

The second thing banks will need to do is rethink their underwriting criteria. Historically, banks have leveraged a combination of business credit files and manually-evaluated financials to make SMB lending decisions. With their newfound access to comprehensive business information, banks can begin to underwrite SMBs using other metrics. The precise strategy for this will vary bank-to-bank, but data such as revenue pipeline, transactions processed, marketing campaign success, vendor repayment rates and others can all potentially be factored into lending decisions going forward.

This will create an opportunity for data-driven fintechs to build credit models and underwriting software based on novel combinations of nuanced data. We’ve seen a proliferation of fintechs building credit models using alternative data in the consumer credit segment. Leveraging the same innovation for SMBs will enable banks to lend to SMBs who may not have the credit history or financial profile to qualify for financing under traditional approaches.

Lastly, banks will need to update their loan application processes to reflect the new reality. Banks should look to build automated credit decisioning models that mirror the innovations seen in consumer credit. Because banks will already have all the crucial information they need on their SMB customers, there will no longer be a need for lengthy, time-intensive loan applications. Instead, SMBs should be able to apply for financing with the click of a button. Financing options should be built directly into business banking portals, and banks should be able to return lending decisions in a matter of hours or days, not weeks.

In addition to making loan applications quick and easy, banks should make their customer account onboarding as seamless as possible. Currently, SMB-focused neobanks and fintechs make it significantly easier to open an account than incumbents. To increase onboarding speed and improve customer experience, banks can partner with fintechs like Middesk, which provides holistic “Know-Your-Business” (KYB) services and improved onboarding workflows, or Blend, which offers quick, customizable digital onboarding experiences.

Serving as External Corporate Treasury

With SMB customers enjoying the benefits of an integrated command center and easy access to capital, banks should next move to improve AR/AP processes and optimize cash management for SMBs.

AR/AP is perhaps the most important component of any business – it’s how they manage cash and get paid! Banks should plan to work with vendors building solutions in the space to eliminate costly human labor hours and increase accuracy of payments.

Vendors have taken various approaches to solving the AR/AP problem. Lockstep, for example, takes the view that AR/AP are inherently connected and looks to double-verify counterparties’ records to ensure accuracy, while leveraging their own integrations into ERP and accounting apps to monitor money movement and accounts outstanding. Auditoria, a vendor focused on AR, relies on AI and machine learning to monitor and collect from high-risk accounts, builds incentives for clients, and mitigates bad debt write-offs.

By embedding themselves into the crucial AR/AP process, banks will be well-positioned to offer payment solutions to their SMB customers. Rather than recreating the proverbial wheel, banks should partner with the numerous vendors innovating in the space. Orum is building a vast data network to develop “ACH risk intelligence” enabling real-time money movement and best, least-cost routing over multiple payment rails. Privacy’s new product for enterprise, Lithic, offers seamless virtual credit card issuance, creating an efficient, lucrative way to make business payments. Melio offers solutions that allow businesses to make payments via bank transfer or card, even where cards are not accepted.

Partnering – rather than competing – with these vendors will enable banks to remain at the center of their SMB customers’ operations while monetizing services that SMBs have already demonstrated a willingness to pay for.

Repositioning as Strategic Advisor and Business Partner

Now at the center of a comprehensive suite of core business solutions, banks will need to build out the value-added offerings that will cement their transition from provider of traditional banking services to true business partner and strategic advisor.

Data from the command center will enable banks to extract key insights on advertising, marketing and business strategy. Some of this can be automated but differentiated FIs will invest in training current employees or building new teams that focus exclusively on translating SMB data into actionable insights.

Here, too, there will be opportunity to partner with software vendors. Square and Shopify have been early leaders in this segment, but banks should look to partner with fintechs with the expertise to help their SMB customers prosecute their businesses in our evolving digital landscape.

Fintechs should consider building solutions that capitalize on banks’ position as an effective distribution channel for value-added services. Founders building solutions for legal services, embedded business insurance products, modern hiring solutions, and others should seek out banks as a natural partner for growth. Banks, for their part, will need to be proactive about adding these products to their stack and figuring out the best way to monetize these solutions as they move deeper into their role as SMB partner.

Over time, banks’ financial command centers, proactive capital offerings, core business solutions and value-added services will cement them as part of the core infrastructure and distribution on which the SMB technology stack is built. Indeed, as they pull in more services and refine their offerings, the very best banks will come to resemble AWS for SMBs – SMBs will be built on banks.

In this final installment of our series on the future of SMB banking, we’ve worked to identify some of the steps that banks and fintechs will need to take to enable a future for SMBs with banks at the center. We believe there are a few high-level takeaways from this series that will be true for most incumbent banks:

1. The SMB market represents a massive untapped potential revenue stream for banks, with key features like analytics, forecasting, cash management and improved lending commonly requested
2. SMBs have demonstrated their willingness to pay for value-added services, and the vast majority would prefer to get them all from one trusted provider
3. Regional and community banks are well-positioned to grow SMB market share given their existing deep customer relationships, large balance sheets and versatile business models
4. Leveraging fintech partners will often be the most effective way to quickly deliver the solutions that SMB customers want

In Part I of this series we spent time discussing the current SMB banking landscape, offering a frank consideration of the shortcomings in many incumbent banks’ suite of SMB solutions. In Part II we laid out our vision for the future of SMB banking, one with banks at the center of an expansive hub of business analytics, financial services, and strategic advice built expressly for SMBs. In Part III we walked through the steps that the ecosystem will need to take to achieve that vision, offering a sample of the possible paths to do so.

While the themes discussed in this series are broad, we hope they paint a solid foundation for visualizing one potential future of SMB banking. If you’re a founder building in the space, a bank wanting to discuss, or are generally interested in engaging further, we’d love to hear from you.

Canapi Ventures was built to connect innovative founders with the financial ecosystem players that will benefit most from their solutions. We love operating in this dynamic segment and look with optimism to the changes – near-term and long – that we’re excited to be a part of as, together, we build The Future of SMB Banking.

‍

‍