Kabbage's Fresh Idea for Small Business Finance

Millions of small businesses lack the credit scores or financial track record to clear underwriting obstacles for a bank loan.

What many do have, though, is a Facebook page—which just might make a difference in landing crucial inventory financing from an alternative online lender that includes social-media content in its decisioning criteria.

For the past three years, Atlanta-based Kabbage has used social media analytics in part to quantify a borrower's propensity to repay. The underlying logic, says chairman and co-founder Marc Gorlin, is that a small business actively promoting itself or receiving customer attention through these channels is a better risk candidate than a less socially savvy merchant even with a similar credit score and product line.

"We've learned that if someone has added Facebook or Twitter data" to their Kabbage account, says Gorlin, "they are 20 percent less likely to be delinquent."

So Kabbage encourages borrowers, in exchange for fee discounts, to detail their various social media and business activities. (It refers to this aspect of its offering as "Social Klimbing.")

In one year, Kabbage's annualized advances have grown from $15 million to $200 million, putting it within a growing segment of alternative finance options for small outlays that small business can't get from commercial banks—either because it's not profitable for the banks or because the businesses don't fit standard lending criteria.

The number of new small-business loans under $1 million fell by 5 percent last year, according to data from the Federal Reserve Bank of New York, while the dollar amount declined 7 percent.

"Banks by and large say no," Gorlin says. "It's not entirely their fault. [For many banks] it's not economical to put smaller lines out like $250,000 to small businesses."

But there is a chance that platforms like Kabbage's could help banks, by serving customers that banks have to turn down. So Gorlin is now looking to partner up with banks to get referrals.

Gorlin wouldn't name names, but he says that Kabbage, which in February hired former Citigroup investment banker Simon Yoo as its chief financial officer, is talking with several banks about adding the Kabbage cash-advance platform to their commercial lending systems.

"What we think we can do for banks is essentially bring them that automated process, where banks can start monetizing their small-business customers where they haven't been able to before. We're talking to a number of banks about starting to do that."

But Kabbage's use of social-media metrics is still an immature field, and a question has to be raised as to whether it's workable for a regulated institution, says Aite Group analyst Arkady Fridman, a former Paypal executive.

Banks "can't deny a loan based on social-media data" where age, race, religion or similar factors may arise, Fridman says. "That's where they get into regulatory constraints."

While Facebook activity is hardly the only criteria used in scoring models, Kabbage's interest in a client's social media or other operations metrics can often be a deciding factor in providing the advance funds, which to date have mostly been to online merchants selling on eBay, Amazon or Etsy.

Besides social media output, Kabbage encourages applicants to also supply information like historical employee levels and the records of the company's use of UPS second-day air, which might be taken by Kabbage as a signal that the business puts a high priority on customer service.

"We call that the 'space between that data' to decide if we're going to offer them capital or not," Gorlin says. "If we know someone has been shipping antique mugs for at least two years for eBay and Amazon, always ships out via two-day UPS air, has more than 500 friends on Facebook, and is always sending out deals on Twitter," he explains, "they are a better risk than the other guy regardless of individual credit scores."

Alternative business lending has been centered in recent years on factoring and asset-based lending models from firms like CIT Group, or equipment/property leaseback arrangements from the likes of AIC Ventures.

Funds from Kabbage, however, are not loans with interest rates, but rather advances for equipment and inventory purchases. Borrowers have six months to repay the advances, with most of the fees (2 percent to 7 percent of the amount of the approved advanced) levied in the first two months of the loan.

Kabbage dispenses between $500 and $50,000 in its cash advances, and it is testing financing levels of $100,000 to some clients.

Whereas a bank would require extensive and audited financial data, says Scott Thompson, the former PayPal president and Yahoo! ex-CEO who was recently appointed to Kabbage's board, Kabbage "offers up this very simple signup flow," where the application and approval process can take less than seven minutes.

"What they've done is they've assembled a richer set of data, they have better technology, better science, better attributes, and are looking at better signals to try to attempt to get a current understanding of what your small business is," Thompson says.

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