January 20, 2020 by Sujay Seetharaman

(Originally posted in Pipecandy Newsletter #98)

“Being poor and having no credit history doesn’t mean you’re not creditworthy” – Jonathan Swift.

Fondly recalled as the father of micro-credit, Jonathan Swift set the earliest example of alternative finance. In the 1700s, he started the Irish Loan Funds to provide credit without collateral to the poor of Dublin. By the 1800s, there were over 300 such loan programs. These loan funds started on a charitable basis just like how Softbank works today, but unlike Softbank continued to grow and play a positive role in alleviating Irish poverty throughout the 19th century.

In the commercial lending world, alternative lending is the equivalent of micro-credit in the consumer lending world.

Prior to the financial crisis of 2008, the number of commercial loans to small businesses – the traditional borrowing option – continued to grow at double-digit rates. This came to a screeching halt during the financial crisis. ‘The Big Short’ is a great movie, if you’d excuse me stanning!

Loans by large banks to SMBs between 2008 and 2011 were practically non-existent, while loans by small banks dropped dramatically. The total amount of commercial loans to SMBs between Q2 2008 and Q2 2010 declined by $40 billion.

Surprise: VCs don’t fund most of eCommerce or anything!

Equity investment through Venture Capital was also drying out. US VC activity was at a decade-low in 2009, with 4,491 deals struck at a total deal value of $27 billion compared to 2000, when the same number of deals were made at a total deal value of $66 billion. As of 2019, VC funding is yet to hit pre-recession levels.

There has been a visible shift in VC activity from early-stage deals to mid and late-stage deals since 2012. A combination of this shift in VC activity and the restrictions on traditional lending left entrepreneurs scrambling for capital options.

It was around this time that the intersection of finance and technology (or fintech lending) started going mainstream. Crowdfunding platforms Kickstarter and Indiegogo were born. P2P lending and Merchant cash advancing companies followed suit. Although these funding channels were well in existence before the financial crisis, they didn’t really proliferate until banks shut doors in 2008. In the last 2 years, even POS companies such as Square, Shopify, and payment processing companies like Stripe have entered the alternative lending business, offering SMBs convenient access to funds at flexible payment terms.

With a specific focus on eCommerce small businesses, we set out to define the TAM (Total Addressable Market) for Alternative Funding in eCommerce.

Sorry moneybags! eCommerce lending won’t make you billionaires.

E-commerce companies encounter a variety of challenges to grow – from tech to inventory to fulfillment, the cash flow cycles are challenging for the unfunded. Qualifying for a business loan from a traditional lender isn’t always an option, for reasons we saw earlier. Fortunately, alternative lending companies offer a clearer path to financing.

Companies like ours provide these lenders with alternative data to help spot lending opportunities.

According to the Small Business Administration, if you make less than $7.5M in annual revenue and you are not a manufacturing company, you are a small business. There are 30M SMEs but stats are damned lies. There are only about 8M, according to this article. According to SBA, 8.6% of them are retail businesses. That’s about 688K. Our estimate is that there are about 791K companies in the US that are in the eCommerce business, making less than $7.5M. Now it’s totally another nightmare that several of them go unreported. Who likes taxes anyway? If you wonder how our numbers are more than SBA’s even though we take into account only eCommerce merchants, read the previous line again.

Staying with the purported 8M figure, at the end of 2015/2016, only 50% of all SMEs (i.e. 4M) reportedly secured financing. Applying the same 50% ratio to the 791K eCommerce merchants, we get about 396K merchants that are eligible for loans. In reality, there are only about 100K companies worth lending to!

Here’s why: Of the total 791K eCommerce companies, nearly 60% makes less than $100K a year. That segment is unfit for loans. They are hobbyists (Think of website selling Kamala Harris campaign swag. Party’s over!). Nearly 50% of them go out of business every year and a lot of them simply drop ship from platforms like Alibaba. They neither have the business model or branding that is needed to become sustainable businesses. So, as an alternative lender, you can reliably lend only to those SMEs that make revenue between $500K – $7.5M.

So the total addressable market is 83K companies and not 396k. Alright, let’s add goes up to 98,000 if you include eCommerce companies that make up to $25M a year (Source: us). If you make more than that, banks would love you unconditionally. What about those sellers on Amazon, you may ask. They are just difficult to find and that’s how they like it. So, let’s stick to that 98k.

Show us what’s in your pocket!

The average loan amount for small businesses can vary anywhere from $10,000 to $1M. The SBA says most lenders want to lend between $50,000 and $100,000. Assuming a $75,000 average, the total possible loan corpus is 98,000 companies x $75,000 = $7.5B at best! Tell us if you can find another way to calculate the total lending potential more reliably.

Not much, I say!

There are an estimated 300 companies in the lending space. A few popular names that come to mind are Clearbanc, Assembled Brands, Vyze, etc. They focus on eCommerce.

VCs have infused at least $12 billion dollars into fintech startups, and there were 10 mega-rounds in Q4 2018 alone. There’s also been an increase in the number of private equity firms, including those operating on behalf of large banks, seeking to fund fintechs. The fintech market is maturing, shown by a shift in VC activity from early-stage rounds to mid and later-stage rounds.

Major players like Clearbanc have invested some $100M in over 500 companies, which is an average lending rate of 200K, 3x the market average! By the end of 2019 alone, it says it will have lent a fresh $1B in loans! With non-traditional players like Shopify & Stripe jumping into the scene, we expect to see a squeeze-out from within the 300 upstarts. If we take $7.5B as the total lending opportunity, with players like Stripe and Shopify turning on ‘lending as an embedded feature’, there would be much less left for non-platform lenders.

The total addressable retail eCommerce market for loans, with its long-tail nature and seasonality, will continue to remain shy of 100,000 companies.

Given this narrow TAM, well-funded lenders like Clearbanc and platform-based lenders like Shopify and Stripe, the shift in VC activity to mature deals is proof that there isn’t a lot of fish in the sea really.

Sujay Seetharaman

Market Analyst @ PipeCandy

Currently donning the Researcher's hat. Talks to himself.