What the banks could learn from crowdfunding

Without growth of SMEs, we will never get any serious jobs growth

Dragons' Den is a peculiar form of SME financing, a subject that is seldom far from the news these days. Although mostly an exercise in ritual humiliation, as a form of entertainment, TV-based venture capitalism does have a few lessons for the real world where even central banks are trying new policy instruments to try and get money flowing towards smaller companies. Closer to home, a new bank is being established with a sole focus on SME lending – the Strategic Banking Corporation of Ireland, with €500 million in funding.

The ECB has drawn lessons from a recent UK scheme to try and get lending flowing to the critical smaller company sector, particularly in peripheral euro zone countries where the credit channel remains stubbornly blocked.

Indeed, many of the ECB’s recent headline-grabbing actions are essentially attempts to get cash to hard-pressed SMEs. So far, without much of a result.

Closer to home, an Economic and Social Research Institute conference last week was devoted to the topic of how SMEs get credit. It confirmed much that we suspected: Irish smaller companies rely mostly on banks for their financing needs and the most exotic forms of lending that they typically experiment with amount to borrowing from family and friends.

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Credit channels

Venture capital, crowd-funding and other credit channels, with one or two notable exceptions, do not loom large in the minds of Irish entrepreneurs.

Understandably, the conference called for development of these channels, along with more education for SME owners and managers and simplified access to forms of credit that do exist but which, for one reason or another, are not accessed by smaller Irish companies. SMEs are important, more so than many of us realise. Most people work for an SME, not a giant foreign multinational tech company. If there is to be jobs growth that takes us back to full employment, it will come from the SME sector.

The high profile given to the excellent work of IDA Ireland in maintaining inward foreign direct investment is understandable. Supporting, indeed increasing, the resources available to the IDA is crucial. But this can only be one part of the solution to our jobs crisis. Without growth of SMEs, we will never get any serious jobs growth.

The Dragons' Den approach to SME financing hints at some of the issues. It provides a perfect illustration of the potential risks and rewards. Somebody has to pitch an idea, somebody has to judge it sufficiently attractive for cash to be forthcoming.

The appeal to a panel of Dragons is not dissimilar to crowd-funding, albeit on a smaller scale and face-to-face rather than web-based. But it’s also similar to trying to persuade a bank manager and just as likely to be successful.

Historically, banks appear to have been interested mostly in asset-backed lending, explicitly or implicitly looking for property as collateral. Bankers' ability to measure and control risk is not particularly high: why would we expect it to be so? In any event, the last thing bankers currently want to do is to take risk, whether or not they are more or less qualified than than a Dragons' Den panellist to judge that risk.

One idea, perhaps for our new SME-focused bank, would be to combine the best of all of these approaches.

New apps

Lending is risky, particularly to start-ups. Crowd-funding is one way of spreading and reducing risk: all of those micro-decisions to lend money contain at least one, macro, piece of wisdom: that of the crowd. Rather than pretend to be good judges of restaurants, ideas for new apps, items of clothing or whatever, bankers could just leverage that wisdom.

If somebody has managed to raise some crowd-based finance, a bank could simply offer to match it (perhaps in terms of multiples of the original amount).

The existence of a large number of people offering microfinance to a small company or entrepreneur reduces or even removes the need for the bank to figure out whether the idea is a good one; a lot of the research has been done, some of the risk is reduced.

There is nothing to stop a bank from running the crowd-based finance process itself in order, at least, to maintain the integrity of that process.

More people might even be attracted to the crowd when it is organised in this way. Given the paucity of cash available to our SMEs, it is surely worth a try.