The new wisdom in credit ratings for SMEs

Jessica Ellerm is a thought leader specializing in Small Business and the Gig Economy and is the CEO and Co-Founder of Zuper, a neowealth disruptor in Australia.

Back in 1968, Dr Edward Altman was responsible for a major innovation in the field of credit risk analysis for corporate businesses – the Altman Z-score. While it transformed risk assessment for this sector, for over 70 years it failed to cross the turnover divide, in any meaningful way, and enter the world of SME finance. This is now changing, thanks to Altman himself, and the fintech revolution currently taking place.

The Altman Z-score is a formula for predicting the probability of bankruptcy, within a time period of 2 years. It is comprised of a combination of common financial ratios, and has been found to have an accuracy rate of around 80% – 90%, when predicting bankruptcy one year out from the event.

Since its creation, multiple variations of Altman’s formula have gained traction in the credit risk assessment of manufacturing businesses, non-manufacturing businesses and privately held companies. Until now, the Altman score has been predominantly used for large businesses, however this is now changing, and Altman is at the heart of it.

Wiserfunding, Altman’s company vehicle for the model he’s become famous for, has now created a version of the original Z-score that specifically caters to small businesses. The company has partnered with modefinance, a company that claims to be ‘the first fintech credit rating agency in Europe.’

The technology is culturally and technically game-changing for small business, who are typically subjected to opaque risk assessment practices from lenders. If Altman’s ratings end up being widely accepted and trusted by lenders, like personal credit scores are, it could eliminate the typical assessment bottleneck that often delays or blocks access to much needed capital. From a cultural perspective, it could also significantly shift the power dynamic in lending, back to the SME customer, who’s ownership of their rating will enable them to better control pricing.

From a ‘future of the industry’ perspective, if Altman’s score gains traction, it could mean building a lending business on the premise of being ‘better at risk assessment’ won’t be quite as interesting or valuable any longer. Obviously if you could beat Altman’s score with your proprietary model, then you would, but if you couldn’t, it wouldn’t make commercial sense to use your own IP. Instead, in this view of the future, a fintech lending business would need a better product, experience and overall offering to an SME to remain competitive.

The problem to solve for SMEs is access to credit, in a responsible way, that helps not hinders growth and doesn’t trap a business into a debt cycle it can’t escape from. Once that problem is solved, the next problem might be how to optimise use of it. If the first problem is on the cusp of being solved, maybe we need entrepreneurs who are ready to start solving for the next one?

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