From analogue to digital ecosystems – Unlocking new opportunities for founders & banks
By Ruth Schöllhammer,
Advanced
ndgit series: Experts talk about banking disruption
by Ruth Schöllhammer, Chairwoman of the Board, German Founders’ Association
Money is cheap. So why are times bad for business founders who need a loan?
Lending money can be complex and expensive for financial institutions, which face strict compliance and transparency rules (many of which were introduced following the financial crisis over a decade ago). While digitisation could make life easier, its progress is often stalled in operational silos with change viewed by various bank departments as a threat rather than an opportunity.
At the German Founders’ Association (Deutscher Gründerverband), we held numerous discussions with founders, start-ups and young entrepreneurs, as well as banks, insurance companies, crowd financiers and consultants. We have come to the conclusion that, despite innovation in banking services, financing options for young entrepreneurs have not improved significantly. That’s bad, not only for the people affected but also for our country and our economy.
Even though half of the population has thought of becoming self-employed, and start-ups are being hyped up like pop stars, it’s not enough to boost new business growth. What founders really need is financial providers to deliver planning security, transparency, fast decision-making processes and support, particularly in the start-up phase.
In an analysis of bank and lending processes for women entrepreneurs, the German Founders’ Association identified the following challenges:
Effort and complexity organising necessary documentation for business evaluation and financing offers
Lack of commercial and business financial planning experience among founders and start-ups
Lack of collateral or low-risk protection to hedge the default risk
Lack of tools to evaluate qualitative and quantitative success factors of business concepts
Little use of control systems by young entrepreneurs in order to recognise and manage business risks in good time.
Banks also recognise that there is an issue. For example, KfW confirms that despite a period of financial stability and good interest rates:
In some cases, finance/credit rejections may be due to too much emphasis on historical data and instead of success factors as well as the problems young companies have providing sufficient collateral for accurate evaluation.
Based on our experience with founders, we have put together the following 7-point plan to help encourage German investment and entrepreneurial growth:
Improve core business processes to attract new customers
The digitisation of banks and the integration of financing partners into a wider digital ecosystem can help banks to operate their core business more efficiently and successfully. This, in turn, allows them to create more successful business funding models for their customers.
A prerequisite for this is the standardisation and automation of individual processes. To do this, they need to clarify the decision-making journey, what information and who is involved. Processes should be embedded in a consistent IT structure with secure data exchange and suitable integration with necessary partners. Any complementary products and services should be easily supplemented by open interfaces.
Standardise business and financial planning to create greater transparency
For banks and financing partners of start-ups, the process usually begins by examining a business plan. There is currently no standard format for these. Our own experience shows that each bank employees has a different interpretation and view on the quality of a business plan. Accordingly, the conversation that follows depends on the individuals involved.
Entrepreneurs could benefit from delivering clearer and more consistent plans using a standard digitised process. Working with a competent consultant, this could be achieved by completing a comprehensive questionnaire covering the following items:
Business idea
Personal requirements
Detailed customer description
Derived sales concepts and marketing concepts
Legal aspects
Logistical planning
Sales and financial planning*
*While sales planning can be based on site analysis and external third-party market figures, manufacturing and supplier costs must be demonstrably documented.
Gathering information in this way would ensure that every plan met the quality requirements of the financing partners. The entire process is transparent and audit-proof for the founders and makes the information easier to assess by key decision-makers. In addition, it increases planning security and promotes greater efficiency throughout the financial application process.
Deliver meaningful ratings to improve forecasts for founders
Being able to access more accurate and structured information, would allow for better evaluation of the business concept, and ensure that both qualitative and quantitative success factors were considered. For example:
Qualitative aspects
Quantitative aspects (financial planning)
· Management
· Customer focus
· Pricing policy
· Organisation
· Corporate Management
· …
· Liquidity
· Profitability
· Income Statement
· …
At the moment, valuation of business models is still primarily based on historical data, which start-up founders simply don’t possess and, therefore, cannot submit. To add to the complexity, individual banks use different systems for evaluating business concepts. For example, the German Savings Banks and Giro Association (der Deutsche Sparkassen- und Giroverband) classifies companies into 15 groups, the Genos (Genossenschaftsbanken) into 16, Deutsche Bank into 14 and Commerzbank has more than 20 levels. The credit index of Creditreform, on the other hand, has only eight groups (see also Die KMU-Berater: “Vergleich der Notensysteme der Ratingverfahren der deutschen Kreditinstitute für Unternehmen”, German).
In our opinion, the rating of start-up or growth concepts based solely on historical data is insufficient to assess future business performance. Banks are missing out on great opportunities to support successful entrepreneurs as long-term financing partners. The inclusion of a “founder rating” is, therefore, urgently needed in order to strengthen entrepreneurship. This also applies to the evaluation of growth concepts that have only a limited connection with the history of a company.
Focus on Risk Prevention to strengthen creditworthiness and reduce the risk of default
Standardising and digitising founding company data not only optimise the evaluation processes, but it also enables the automation of security and safeguarding services. For instance, information can be integrated seamlessly by affiliated insurance partners in order to offer start-ups a business-adapted risk-mitigation package that covers factors such as:
Illness
Death
Disability
Remaining debt
Business interruption
Bad debt
Liability
…
Providing security for the founders and their dependents, this also increases the creditworthiness of future entrepreneurs with their financing partners. Within a digital ecosystem, this data and information can be made available to any authorised third-parties via the banking platform.
Make processes more efficient to accelerate start-ups
It’s not unusual for start-ups to wait two months for a financing offer or, if they are unsuccessful, to be informed of a rejection which means they need to start all over again. Such a process often takes six months before financing can be clarified. Would a landlord, supplier or customer wait this long?
Slow decisions cause many new businesses to fail prematurely as founders lose confidence through uncertainty and doubt. They are likely to hear “I told you it would not work …” another reason that dampens, rather than strengthens, start-up activity in Germany.
Fully exploit the market potential of SMEs
Micro and small enterprises play a crucial role in Germany’s local economy yet are at a disadvantage when it comes to access to credit. A study published in April 2019, “The Big Business of Small Business” shows that traditional credit systems do not meet their needs and they continue to struggle with barriers to finance.
It seems that the chances of securing a loan on favourable terms are not the same for large and small businesses. And, for companies with fewer than 50 employees which according to the Institute for Small and Medium-Sized Enterprises (Institut für Mittelstandsforschung) in Bonn make up over 97% of German companies and account for one third (32%) of social security contributing employees, the financing situation has not improved despite low interest rates in the last three years. Indeed, 9% of micro-enterprises consider access to finance as their most pressing issue.
Invest in digital ecosystems to ensure the future viability
New global markets require new thinking. The future survival of banks will depend on technology and innovation on one hand and customer behaviour and expectation on the other. It will require banks to adapt existing processes and also to adopt new approaches that are based on ever-changing market drivers and needs.
Founders and entrepreneurs are used to using digital ecosystems such as MyTaxi or DB Navigator, not just for private use but also within their commercial activity. They expect corporate processes and consulting to be digital and easy to access, similar to online banking. What is needed are independent, transparent procedures for granting loans, regardless of historical data and free from the subjective assessments of local bank advisers.
Some banks are already taking major steps in this direction with the smartaxxess digital ecosystem. This provides a collaborative digital platform for founders and entrepreneurs, consultants, insurance and financing partners and is a promising concept for the future.
You as a bank can as well build a supportive ecosystem like the one above with technology by ndgit.
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