Interview with Bill Phelan of PayNet – Spring 2019
I recently sat down with Bill Phelan, President of PayNet for a conversation on the state of the online small business lending industry and I found his insights powerful and instructive. As he puts it, “I founded PayNet on a hunch that the credit market for Main Street didn’t work very well. My hunch was right.â€
He saw that large Wall Street firms had ready access to information and capital through sources like Bloomberg, S&P, NYSE and Goldman Sachs. No one was meeting the $4 trillion need of main street American small businesses.
Enter PayNet and the journey to a better, faster and cheaper credit system for small businesses in America. PayNet, which celebrates its 20th anniversary this year, was recently acquired by Equifax, Inc. The addition of PayNet’s expansive commercial leasing payment data combined with Equifax’s differentiated commercial data assets will help drive customer growth in the small and medium commercial space.
Four ideas lie at the core of Bill Phelan’s message about the future of financial services.
First, Main Street America suffers from poor access and high cost of credit. Small businesses measure wait times for capital and credit from traditional financial institutions in months. Costs are compounded by mountains of paperwork and small business borrowers’ lack of confidence in getting approved. The broken system means Main Street companies don’t grow as much as they could or reach their full potential. Studies show this challenge costs jobs, lowers wages, and hurts manufacturing industries.
Second, the entire financial services industry ecosystem is being wired together right now. In his view, we started this process in the wake of the financial crisis and the Great Recession with digital banking and online lending offering new products and services to small businesses faster than ever before, but really this was just the “tin cans strung together†phase. We are now in the process of building a massive, interconnected financial ecosystem, which he likens to the development of Ma Bell and the national telecommunications revolution in the early part of the 20
th century. Banks, Fintechs, large and small technology players are all racing to connect the entire industry together with APIs and it will yield profound benefits to Main Street American small business borrowers. Faster, cheaper and safer access to capital is here now, but there is more.
All that interconnected and specialized ecosystem has a purpose, according to Phelan.
“What purpose?†you ask.
“One-click credit.â€
Having listened to him, I happen to agree that we are on that path. Achieving that goal will not be easy or direct, but will build, develop and emerge rapidly over the next few years.
“And who will be the ultimate beneficiary of this interconnected ecosystem of specialized firms?†As Bill Phelan tells it, “Main Street American business men and women. They will have immediate access to needed capital, in real time and at lower cost than ever before. When we leave behind the mountains of paperwork required to apply for a traditional small business loan and . . . combine that with algorithms that anticipate business needs in advance, we create a digital ecosystem that benefits everybody.â€
Fourth, increasing specialization will drive this wiring process and yield a future of “one-click credit.†As technology companies grow, they will specialize in one part or another of the credit process.
“There will not be one Amazon of lending that conquers the entire industry,†Phelan notes.
There will be data companies, analytics companies, lending companies, technology services providers and banks all working together in varying degrees of harmony and discord on this path. Each will provide a specific service for the ecosystem.
This view of the future of financial services and lending clearly makes sense and will afford small business entrepreneurs a fresh chance at the American Dream—and they will get it in real time.
Interview Transcript
Scott Stewart (SS)
How and why did you start or join your company?
Bill Phelan (BP)
I started PayNet to fix a messed up credit market. I saw Main Street America used trillions of dollars of credit each year. But no good information existed to make it flow easily. NYSE, Bloomberg, S&P, Goldman Sachs all make capital available for Wall Street.
I had a hunch that the credit market for Main Street didn’t work very well.
My hunch was right.
Main Street America suffers from poor access and high cost of credit. Wait times are months. Costs are mounds of paperwork. Lack of confidence in getting approved. The broken system means Main Street doesn’t grow as much as they could to reach their full potential. Studies show this costs jobs, lowers wages, and hurts manufacturing industries.
SS
Where is your company heading and how will you get there?
PayNet is working with others to wire together the financial ecosystem. This ecosystem will enable faster lower cost access to credit for Main Street. Partners include technology and software providers like OnDeck. New sources of financial data are becoming available like digitized financial statements through our Credit Memo product. New forms of credit models are being developed like composite credit models that combine personal and business data to present a full picture of the business owner and the business.
PayNet believes a big industry will develop so we are investing in groups like the Innovative Lending Platform Association (ILPA). ILPA can act as a funnel to capture the key issues on regulations. It can also provide networking opportunities for the lenders.
(SS)
Where will the industry be in 5 years?
(BP)
Access to capital will be one-click for Main Street America. This means a business owner can fill in some basic information like name address and business type and the systems will take it from there. Once the basic information is captured, the computers can create the credit file. They can in minutes pull credit bureau data on the owner and business. They can also request financial statements from the business electronically – this saves the “mounds of paper work†and hours of time for the business owner collecting and reporting financial statements.
Once the credit file is assembled the credit models can start to analyze and recommend. They can quickly figure out if the business, perhaps a farm, will it need a seasonal payment product. If the business is a medical practice, will it need expensive diagnostic equipment. The credit model can pick products, loan structure, loan term, and pricing terms that are likely appropriate for the business.
From there the analyst takes over. Rather than having expensive credit analysts googling for data, now they are analyzing balance sheets and P&L statements to get the right product and terms for the business.
The future is bright for Main Street businesses because the credit ecosystem will make their access to capital faster, easier, more certain. This will free them up to spend more time with customers, to market their services, and building new products.
SS
What is PayNet’s role in the digital lending revolution?
BP
PayNet is the credit assessment of 25 million Main Street businesses. Our role is to provide the best credit models available to ensure credible and reliable assessments of private companies. Most private businesses don’t have audited financial statements. They don’t publish financial records like public companies do. So this lack of financial information on private businesses holds back lenders ability to make credit available. If a lender is unsure of credit risk, the lender will charge more for credit and will request more information to lower their perceived risks.
PayNet’s job is to provide a safe, fair access to financial information on private businesses. We run a data consortium that collects payment history, public records, financial statements. This information is contributed by the member lenders who gain access to the database for credit assessment purposes. We create credit assessments out of this financial data.
SS
What is happening in the digital lending revolution and why is it important to be part of it?
BP
Bigger question is how does this system get wired together? Wiring together the ecosystem is what is happening right now. We don’t see it every day. On any given day, programmers are setting up links between different systems. It’s an API nation. If you had a wall map of America with API set up you would see the wiring getting built out, almost like a house getting built, by all these developers. Wiring that ecosystem together is what we are experiencing right now and it is subtle and we don’t see it, but it is an important step to get to one click credit.
One click credit it where it is going. Some will play in the high touch market and some are going to play in the fast get you credit quickly and safely with right price and the right terms.
Once the system is completely wired together, it will be hard for new entrants to get a seat at the table.
SS
Let’s continue on that path. I agree that we are on the path toward one click credit. Is it going to go further than that? Do you see 10 years from, as you talk about wiring this ecosystem together, do you see voice activated credit as you communicate with your personal algorithm? I need X for this business purpose and your algorithm says, “Well, here are the 10 available options and let me know which you prefer and I will work it through on the back end and the money will just appear.â€
BP
Some form of AI will occur, but we are not there yet. We are still just trying to put the basics together. We are trying to go from two tin cans with a string to a telegraph system right now and we will eventually get the whole thing wired together pretty tightly.
What we will find is that it might not be Alexa or Siri doing this for us but it might be embedded programs the accounting or cash flow systems that can give the business owner a heads up when cash is running out so they can project ahead. Many business owners aren’t sitting there projecting cash flow statements for the next 6 months, they are worried about their customers, products and their markets. They are usually the chief product officer, the chief sales officer, chief manufacturer. What they need is advice and advisory services through technology and that is where I think this is going.
There are some really interesting programs that can project cash flow for the business owner and they are subtly running behind the scenes that will pop up and say “Hey you might need cash in about 60 days – here are a few offers.†I don’t think it is going to be Alexa or Siri, it will be embedded in the systems of the business owner. Eventually it could get to Alexa, maybe that is 15 years down the road, but first steps first, let’s take the tin cans and get rid of those and wire together the Ma Bell system.
SS
Taking that one step further – how far away are we from the time when the business owner is so confident in the algorithm offering of financial products that she simply authorizes it to make those decisions for her. “Oh I am going to need cash in 60 days?†Not only here are the offers, but instead the algorithm automated everything already and it is done and the cash is coming now. It just alerts you that this is going to happen. How far away are we from that? Do you see that as part of our long term digital future for small businesses to have those kinds of services just appear?
BP
If the robots are going to make the decision maybe we can get them to do a few other things for us on the shop floor or doing some marketing for us as well. Before we get a robot actually signing us up for a financial instrument, maybe what we will see is everything set up and prefilled and ready for signature. I think that is really the problem that we see today is that there is so much unneeded time spent on collecting information or on trying to digitize paper. That is where the friction is in the system. That is where the time burn is.
Think if you have an old car that gets 4 miles to the gallon because it’s just not an efficient engine and that is what we have today. We have a 4 miles to the gallon system that is burning a lot of energy just to get the car down the road or to collect financial information. So lets solve that problem and pre filled applications are the way to do that. The business profiles exist. Within the PayNet database we are tracking 25 million businesses and we have the pre filled credit assessments ready to go, on the shelf. So you can come in and grab them and make a quick decision. So we have to get comfortable with that prefill world first before we get into the complete AI making the decision for us especially on a financial instrument. I think that is a way’s off.
SS
You have this incredible service in PayNet with 25 million small businesses in the database and the prefill systems and we talked a little about how you are going to action that with machine learning. What are you going to do to action that data?
BP
And that the key thing is to make it actionable. Information is great, but if you don’t make a decision, it is just worthless. It’s like the giant library with books nobody ever reads. You gotta make decisions off this stuff and the way to get these decisions made is to have systems that are linked together. For example, the fraud issue. Fraud is going to become a big problem for businesses that are lending.
What we have to do is to make these systems addressable for big problems. There are big problems out there and fraud is just one of them, the underwriting process is another. For many commercial banks the underwriting process takes 60 days. That is a problem.
ILPA members are figuring out how to get this done in hours to a few days. But there are still are challenges there. There is verification that the person on the other side is the person that’s represented. There is filing the liens or making sure that there are no liens or gathering that credit file or gathering bank statements and financial statements. As we see these lenders grow we are going to find is further specialization. It’s like any thing in life – as these lenders get more sophisticated and larger they are going to specialize their businesses. They are going to get really good at getting capital onto main street America, which is really what the mandate is. Ever since 2009 the credit system for American small business has been broken. It was probably broken before then but its really broken now. With the advent of online small business lending through what the ILPA members have done is to attempt to fix that broken system. We are probably in the 5
th or 6
th inning of doing that right now, so there is a lot of work to do.
Addressing big market issues like getting that underwriting faster, making sure there is not fraud behind the scenes going on. Final thing is that compliance is not going away for anybody, CESL is coming down the pike (Current Expected Credit Loss) so the lenders now have to be able to project where those loans are going to be in terms of loss rates over the next 5 years.
We can’t predict weather over the next 3 days and we have to predict where these loans are going to be in 5 years. It like putting a man on the moon or maybe on Mars kind of project so there is a lot of work to do there. There are also some other major issues, but I think ultimately to get to that one click credit we have to figure out the ways of getting all these little elements of underwriting faster.
(Potentially Cut) That’s where I really admire the innovation of the ILPA, because ILPA has helped to bring best practices to the table. We discussed a lot of those this morning certainly with CCPA and a host of other data privacy issues. These are all worth spending time on. Solving big issues is what ILPA is doing and what the fintech members are doing and it is ultimately going to help main street America.
SS
PayNet has been integral to this mission of a lot of our members to move to that one click credit. How do you see PayNet fitting into that ecosystem going forward? How is PayNet going to be facilitating that and moving us to that next level?
BP
We can have a system where everything is embedded in one kind of operating system where we can have specialization. What I mean by that is kind of Apple and Microsoft, both hugely successful, but they took different ways of implementing a personal computer. Apple was all contained in one, they built the operating system, but you couldn’t even open the back of the computer on to work on your mother board with a mac book. With a with the DOS based Microsoft system, it was all disaggregated. We see those two systems developing today.
There is increased complexity of all those jobs I mentioned, of CESL, of underwriting of fraud and its requiring greater specialization so I don’t know if we are going to see one chief cook and bottle washer in this industry. We might see one dominant lender eventually, one Amazon of lending, but that is a way’s off. The market is very large and it lends itself to specialization and niche markets. Some are high touch lenders and some more automated. Business is so large in America, main street America consumes $4 trillion in credit every year. That’s a lot of money. There are 30 million businesses that consume credit and they consume it in different ways. So I think we are going to see more of the Microsoft system initially of specialization, where there will be a very specialized software provider, specialized analytics provider, very specialized technology provider and they will collaborate to get that ecosystem of credit wired up and the ultimate winner will be main street America.
When they can get to the day of getting their credit needs fulfilled between 9 and 5 rather than 11:00pm at night, we will have made it. Most small businesses don’t really get to the finances of the business until 11:00pm. I don’t know about you, but I am pretty tired at 11:00pm after running a business all day.
SS
I think you’re right. It is really hard. That is what they are facing. They have been running their business since 6:00am and then the put their kids to bed and they are back at work and they say “Oh, I have to look at my budgets.â€
BP
Its collaboration that we have to pull together and that’s why I give a lot of credit to ILPA for pulling together like PayNet or Orion and then the lenders themselves. ILPA is a mini ecosystem in itself. I can see the day that this ecosystem will become a rather large business for everybody’s business benefit.
SS
How can Main Street America use technology to become more competitive?
BP
Main Street has a big advantage over large corporations. Main Street is close to the customer. So the business owner can hear faster about changing market needs. The business owner can also make faster decisions about where to invest without a bunch of committees or consensus building. Digital uploading of financial statements saves them mounds of paperwork.
SS
What public policy challenges do you see as the most challenging for your company? Is there anything you can do about them?
BP
Data privacy is a big issue. What’s not well understood is data ownership rights. Ownership rights in the U.S. are based on creation or purchase of an asset. Data is an asset and falls into the same category. The producer of the data is the one who owns it. This means if a business owner creates financial statements, then those financial statements are owned by the business. If a lender creates a payment record of a loan on a business borrower, then the lender owns the data. We have to establish a good understanding of data ownership rights.
SS
Are the US Congress, the regulators or the state legislatures the biggest threat to the industry? How can they do a better job of overseeing our industry?
BP
The biggest threat to a well running credit market is lack of understanding. Regulators hear anecdotal stories about borrowers getting in over their heads and they react in some cases rightly so, by putting rules in place to protect the business owner. In some cases those rules may actually present unintended consequences of restricting access to capital for small businesses.
For example, 1071 requires CFPB to facilitate enforcement of fair lending laws and enable communities, governmental entities, and creditors to identify business and community development needs and opportunities of women and minority owned small businesses (WMBE). To inquire whether or not the business is WMBE, the industry would need to request the following information:
- application and the date on which the application was received;
- the type and purpose of the loan or other credit being applied for;
- the amount of the credit or credit limit applied for, and the amount of the credit transaction or the credit limit approved for such applicant;
- the type of action taken with respect to such application, and the date of such action;
- the census tract in which is located the principal place of business of the women-owned, minority-owned, or small business loan applicant;
- the gross annual revenue of the business in the last fiscal year of the women-owned, minority-owned, or small business loan applicant preceding the date of the application;
- the race, sex, and ethnicity of the principal owners of the business;
- any additional data that the Bureau determines would aid in fulfilling the purposes of this section.
The costs for lenders to comply with 1071 will be higher on a per application basis for smaller lenders versus larger lenders. This means smaller lenders will need to charge more for their loans, putting them at a competitive disadvantage. It might make the credit gap more pronounced as community banks shy away from making loans to local businesses.
SS
This industry began with a promise to upend the old order of financial services delivery, potentially putting incumbents out of business. That sentiment seems to have shifted in favor of partnerships. How do you view what has happened in that regard and where are we going in the future? How is your firm choosing to navigate this landscape?
BP
The partnership approach where a bank and fintech lender work together to provide faster lower cost credit is good. It’s good because it uses the best of both lenders. It uses the inexpensive capital of banks combined with their access to customers in local communities. Bank/Fintech partnerships also use the best of fintech technology to lower the lending costs. Partnerships make sense because they use the best of both.
SS
What will be the industry wide impacts of a recession in the next few years? How has your company prepared for this?
BP
Industry wide impact of recession depends on the type of recession. The real estate crash of 1991 hit a few big banks like Citi. The dotcom crash hit private equity. The Great Recession hit the entire banking system. The next recession could be from several fronts – trade war, debt bubble, terrorist attack. Debt bubble can have the biggest impact because it raises costs for all quickly. We’ll all pay higher costs for access to capital. This means lenders Cost of Funds (COF) goes higher making it tougher for them to earn a spread (profit). We’re preparing for this by providing more portfolio assessments. Assessing the portfolio tells the lender pockets of risks and enables managing those risks.
SS
How do you view industry best practices? How do you hope to help the industry improve its transparency and to drive out bad actors?
BP
Transparency expands markets.
Lenders who don’t fully inform business of their terms create a lemon market and that distorted market drives away good products. Ultimately this results in a collapse of the market. That uncertainty drives out the good actors and the good products.
SS
What is the future of the United States at the confluence of finance, innovation and technology?
BP
Bright confusing future. Bright – tech creating more supply of credit data, movies, music, social connections. More supply expands demand and it leads to innovation. Consumers and businesses will figure out new ways to consume more supply. More goods and lower costs. Confusing – It will take years for the U.S. to sort our data privacy issues and IP ownership rights.
SS
How will the combination of the following forces reshape our civilization in the future?
a. The Internet of Things
b. Big Data
c. Artificial Intelligence
How is your firm positioned to use these technological forces to your advantage and to the advantage of America’s small businesses?
BP
The big tech no one is paying attention to as much is 5G. This enables faster transmissions. More information downloads.
5G is big with transactions 4X faster.
Also, get ready for the cloud and
every device will be connected. This technological change will force banks to become digital or get left behind.
4G is neighborhood ballpark, 5G is Yankee Stadium. It connects billions of devices at metabyte speed yielding response times in the milliseconds. No wait for the website refresh.
5G forces all actors into the digital landscape.
Imagine – Business’ accounting system projects cash flow crunch in 6 mos and offers LOC with risk based pricing in real time. If they don’t they go the way of the buggy whip. 5G is a game changer starting in 2019.
SS
How will the blockchain reshape financial services and how is your firm positioned to take advantage of this technology?
BP
Lowers transaction costs.
SS
I want to transition for a moment into something you have been thinking about and heavily involved in for some time and that is the issue of financial inclusion. There have been a lot of main street businesses that have been left behind after the financial crisis by banks leaving the field. Sometimes being forced from the field by regulators or sometimes by their risk committees, just saying we cannot possibly service this group. How do you see the kind of digital lending revolution, ILPA members and PayNet solving that problem and filling that credit gap? And perhaps you can talk a little bit about the credit gap too.
BP
Sure, absolutely, it’s the ecosystem and by bringing that ecosystem together you solve the problem. One of the most recent research pieces we did showed that businesses in low income and rural areas of America had less access to capital for various reasons. Part of it is that the systems that are wired together today are limited in their capabilities. For example the SBA program. Using the SBA software, but also using their requirements around analytics to credit assess for their credit express products.
What we found is that by just having limited information about the business owners, it makes it difficult to grant credit, makes it hard for the bank to say yes. If you don’t know much about the investment that you are making, you are more likely to not make that investment or to be very cautious with it and say “no†more often.
What we found is that by putting more information into that credit express product and program you can increase the approval rates to rural America by 13% and increase the approval rates to businesses in low income areas by about 10%.
These are meaningful impacts. When you talk about the SBA program with $120 Billion outstanding, getting an extra $10 billion out there to rural and low income and that can be the difference between survival and closing your doors. What we found is that the broader use of information is a way to expand credit inclusiveness and access to capital for low income and rural America.
SS
I think that is something that is driving the interest of our members. That desire and that hope that we can actually help give a small business get a second chance at the American Dream by taking a look at something other than their FICO score.
Can you comment on the data that is underlying that, the kinds of things that ILPA members or the banks are collecting, that might positively impact a credit decision by a digital lender?
BP
Lot of great technology out there and that is what I mean in terms of specialization. Now what we are doing at PayNet is that we are pulling together the financial statements digitally. Again, I mention the mountains of paperwork that the business owner abhors and detests going through. I mention the 60 day process that the business owner goes through to maybe get a yes or maybe get a no and the uncertainty for the business owner there and part of that is that it is so difficult to pull that financial information, so being able to digitize financial statements – there is some really neat technology right now to pull financial statements out of systems like Quickbooks or Netsuite or Peachtree or Zero.
At PayNet for example, our clients can actually request those financial statements and we can get them digitized within 48 hours for the customer. That becomes a faster way again and what we found is really interesting and a more accurate way because when people are having to collect these things and having to type them in, you might fat finger a certain number or you might get distracted by a phone call or you might spill your coffee on the financials, then you are prone to errors. And so what we find is that there is actually more accuracy with these digital systems that can actually map digital financial statements right into digital tables for making smarter decisions.
SS
So you get better decisions, better accuracy, and hopefully a lower cost of capital for those small business borrowers.
BP
That’s right. You can pass on those savings to the business borrower. The other interesting thing too is that we are not advocating to get rid of people here. We are just advocating using people for their highest and most valuable use and what they like to do.
Most of these business people I know enjoy analyzing things. They don’t enjoy Googling for information, or typing things into a spreadsheet, or having to hunt a business owner down to collect an accounts receivable record. So what we find is that we can tee up people to do what their highest and best use is and what they enjoy doing which is doing analysis. We haven’t figured out quite yet with AI and Siri and everything else, how to replace all these relationships that people establish in their heads. They have seen other transactions, have a sense for where we are in the economic cycle and the can bake that into their credit decisions, rather than putting these systems on auto pilot. Anytime you put systems on autopilot it gives us all cause for concern.
That famous line by Ronald Reagan, we drove over the cliff in the convertible with the flags flying and the radio on, but we didn’t know the cliff was there. Don’t put it on autopilot. Let’s make sure we can understand and leverage technology to make people’s jobs more rewarding and valuable.
SS
One last question: What are you most excited about in the next few years for PayNet that is going to make PayNet the company that you want it to be and what will it look like in 10 years? What gets you excited about that?
BP
What is interesting about that is that commercial credit is in the 1970s, but its going to get into the 21
st century and it is going to be accelerating here rapidly. What I get excited about is helping commercial credit realize its full potential. Right now we have things like the New York Stock Exchange and Goldman Sachs and Moody’s and Bloomberg and they work well together to get capital out to Wall Street. In fact a Wall Street public company can get access to capital in a matter of days at an incredibly low price. It is a phenomenal system right now.
What I am excited about in this commercial credit ecosystem is bringing that Wall Street, instant, cost effective capital to main street. Again I mention that $4 trillion dollars. Getting a more standardized capital system for main street America will get a lot of people excited. Once we see the impact of that in enabling main street to jet ahead with their growth plans and not have to worry about access to capital, not have to have uncertainty in their minds about hiring that extra person, or buying that extra plant or piece of real estate maybe I could do that if I had greater capital and access and confidence that I was going to get approved.
This is going to unlock a whole new world of Wall Street for Main Street if you will and that is going to be an exciting time for everyone. Wall Street generates $65 billion of income for various participants a year right now. That’s because it is an efficient mechanism for generating capital and participants are rightly paid for that. Wall Street for Main Street and that $4 trillion can be a really exciting business opportunity for that credit ecosystem so it is a win win for everybody. It’s a win for the economy. Main Street represents $10 trillion of GDP. If we can energize that further or even give it a little bit of a lift through this easier and faster access to capital that is safe, then I think we can help generate further economic growth and so PayNet is positioned to play an essential role in that and I think eventually we will see the day where a company like PayNet can be at the center of the credit assessments for main street America.
SS
I can’t thank you enough for your engagement with us and for your enthusiasm for the future of America’s small businesses. It’s inspiring. Anything else that you wanted to share?
BP
We see that the conditions are really good right now for main street in spite of all the uncertainty of the government shutdown, of geopolitics, of the big stock selloff in December.
Actually main street businesses are very healthy. These are savvy business owners and operators. The default rates on these private companies are lower than the default rates for these large high yield bond issuers. There is a huge misperception about the boogie man of risk for main street America.
Scott
Bill, thank you so much for a fascinating conversation.