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Breaking Free From FICO: The MCA Provider Perspective

For decades, lenders have primarily relied on FICO credit scores to determine loan eligibility.

And although FICO has long been the gold standard, it’s becoming an outdated model to assess risk.

Credit scores never paint the whole picture regarding creditworthiness—as a result, many small and medium enterprises (SMEs) in need of capital are often left out in the cold. 

In response, the use of alternative data sources is gaining popularity among alternative lendersparticularly those in the merchant cash advance industry. By analyzing additional data beyond FICO scores, MCA providers can reach more SMEs. 

In this article, we’ll explore the world of alternative data and how—driven by MCA providers—it’s transforming the SME lending landscape for the better.

The Limitations of FICO Scores

The FICO credit scoring system assigns a three-digit number to rate the creditworthiness of an individual borrower or enterprise. A lower score indicates a higher risk for default on a loan, while a higher number indicates a stronger likelihood of repayment.

The FICO business credit score is calculated based on several factors, including time in business, credit history, and business services. Meanwhile, FICO personal credit score is based on its own criteria.

However, relying solely on FICO scores poses several problems for lenders and businesses alike.

First, by using only FICO scores, traditional lenders can’t accurately determine if a business is experiencing financial struggles. FICO scores show a static picture, but an SME’s financial health is likely to be constantly changing (especially in the current environment).

This was especially true during In the midst of the COVID-19 pandemic, where several banks found themselves “flying blind” when faced with loan applications from both consumers and SMEs. 

Second, on the borrower’s side, it’s relevant to mention that about one-quarter of American households are considered “unbanked” or “underbanked.” These people (and the businesses they own) have limited—if any—financial information available to generate a FICO score. As such, they may be ineligible for a loan or face stricter terms when seeking financing.

Finally, credit scores are assessed based on information contained within a credit report, which is prone to errors for both individuals and SMEs. In fact, on the consumer side, more than one-third of Americans found at least one mistake on their credit report. 

A Paradigm Shift in Risk Assessment: The Case of MCA Providers

When it comes to risk assessment, for MCA providers FICO scores are just one of many factors to consider. In fact, to assess risk and creditworthiness, they put more weight on the real-time financial health of SME applicants. 

With MCAs, rather than dwelling on the past, decisioning is based on current financial data and future sales. As such, SME merchants shouldn’t need impeccable credit to be eligible for this type of financing.

MCA providers understand the dynamic nature of the SME world, where things can change in the blink of an eye. Moreover, MCA providers realize that limited credit history and temporary setbacks shouldn’t define an SME’s creditworthiness. 

So, rather than relying solely on FICO scores, MCA providers consider various alternative data sources, to create a more precise credit assessment of applicants’ current circumstances—this is what is known as alternative credit scoring.

Sources for Alternative Credit Scoring

To understand whether an SME is creditworthy, it’s essential to look into specific numbers concerning commercial and financial operations. This, of course, is what FICO scores are for.

But there’s much more to it.

Alternative sources typically include things like utility bill payments, point of sale data, and even social media presence—they go beyond an SME’s credit history, and give a better understanding of their general behavior.

And while alternative credit scoring is not precisely new—especially for MCA providers—data from other sources is continually emerging, and is worth considering when assessing a borrower:

  • Employees: an SME’s workforce, such as size, average salary, and turnover rate, can be used to assess its ability to attract and retain talent, which can be a key factor in its success.
  • Customers: demographics, spending habits, and satisfaction can all be useful to assess an SME’s market share and its ability to generate revenue.
  • Suppliers: looking at an SMEs supply chain, for things including supplier reliability, pricing, and terms of payment, shows how good an SME is at getting the goods and services it needs.
  • Web traffic: in our digital age, an SME’s website traffic, such as number of visitors, the pages they visit, and the time they spend on the site gives a good idea of the SME’s potential for growth.

Ultimately, the more information, both quantitative and qualitative, that MCA providers can leverage, the more accurately they can assess whether a potential borrower will make payments on time.

The Power of Alternative Data in the MCA Industry

When combined with traditional credit scoring, alternative data sources help MCA providers assess an applicant’s repayment potential based on their intent and disciplined payment behavior. 

By using alternative data, both MCA providers and merchants can benefit in a number of ways.

1. More Accurate and Informed Evaluations

Real-time alternative data gives MCA providers a more comprehensive assessment of an SME’s creditworthiness than a simple FICO score ever could.

Ultimately, a more holistic view means better risk management—plus fewer defaults. And SMEs get a fairer shot at receiving funding. 

2. Bespoke Financing

With alternative data, MCA providers can build a deeper understanding of each SME’s real-time financial situation—and tailor funding solutions and repayment terms that align with each individual SME’s specific circumstances. 

MCA providers can offer flexible repayment options that align with the cash flow dynamics and real-time business performance of SMEs—ensuring repayment obligations are more manageable.

3. More Access to Capital

MCA providers can accurately determine SMEs’ creditworthiness and offer funding to merchants who are overlooked by traditional lenders.

MCA providers gain a new pool of potential clients, while SMEs are enabled to seize growth opportunities and address urgent financial needs. 

Broader Implications and Future Prospects

The shift towards incorporating alternative credit scoring holds significant implications for the broader financial system, with the potential to dramatically reshape the current SME lending landscape.

Here are just three examples of how things are already changing.

1. Addressing Systemic Inequities

Although FICO scores were originally designed to eliminate bias, discrimination continues to taint the data that credit scoring models use today

As a result, marginalized segments of the population and the SMEs they run have often been turned down for traditional lending, keeping them in a vicious cycle of systemic inequity. 

On the bright side, alternative credit scoring could play a major role in mitigating these financial discrepancies. This fresh approach can help level the playing field for all kinds of SME merchants, bridging the financial gap and creating a fairer system.

Once-underserved SMEs can obtain the capital they need and expand their businesses while also addressing historical disparities.

2. Going Mainstream

Looking forward, we can expect alternative credit scoring to make more and more waves in the MCA industry. Already, many organizations are creating hybrid risk assessment models, complementing FICO scores with alternative data sources.

With more MCA providers realizing that there’s a lot of useful—and varied—data to leverage and benefit from out there, the trend is likely to gain momentum.

Meanwhile, as we see more success stories of SMEs benefiting from alternative credit scoring, it will surely inspire others to try similar methods.

This will help bring more SMEs into the credit system—breaking barriers while decreasing the cost of basic lending products for millions. 

3. Innovative Technology

The growing use of loan management software in capturing and analyzing alternative data is where things get quite exciting for MCA providers.

SaaS lending platforms like Onyx IQ can leverage advanced decision engines and automation to process and make sense of the massive amounts of SME applicant data available.

With the ability to quickly evaluate tons of data points simultaneously, MCA providers can advance their risk assessment approaches. This enables them to more easily detect possible defaulters, tweak loan terms, and reduce their own risk exposure when financing SMEs.

The Future of MCA Risk Assessment Is Data-Driven

Access to capital is crucial for SMEs—it shouldn’t be such a challenge to come by. 

Traditional FICO credit scores used to determine creditworthiness fail to paint a holistic, real-time view of an SME’s financial health.

But alternative credit scoring changes all that.

Recognizing the limitations of traditional credit scores, the merchant cash advance industry is leading the way in embracing alternative data sources for credit scoring—and redefining risk assessment for the better. 

By making financing more accessible and tailored to the realities of small enterprises, MCA providers are creating a lending landscape that’s more inclusive, more dynamic, and ripe with opportunity for all parties involved. 

However, working with alternative data has to be done effectively. That’s why choosing a technology partner like Onyx IQ matters.

We’ve got your back, helping you protect your MCA business from unnecessary risks, while equipping you with valuable insights for properly evaluating the merchants you work with. It’s all about striking that perfect balance.

Ready to see how it all works? Schedule your demo today and discover how Onyx IQ can help you redefine risk.

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