Applying Blockchain to Solve the SME Funding Problem

In this guest post, Peter Edgar, CEO of InvestX, looks at how blockchain can solve the problem of SEO funding.

There are many challenges facing small and medium-sized enterprises. SMEs form the backbone of most major economies, but ensuring that they reach their full potential is an issue that has remained without a tangible solution for decades. SMEs still face barriers to entry and scant protection from conditions that would barely affect larger competitors. Up until now, no solution has emerged that would shelter SMEs from these challenges and allow them to reach their full potential.

Banks are, by their nature, risk averse, and so their appetite for lending to SMEs is limited. Last year’s report from the World Bank estimates that 70% of small, medium and micro-enterprises are unable to access the funding they need.

An inability to bring in capital continues to cause significant problems for small businesses, preventing growth and causing cashflow difficulties. Businesses identify the lack of working capital as a major reason for corporate failure, second only to the lack of market demand for their products or services.

Even if small businesses can secure loans, they’re often left with uncompetitive, and unfavourable interest rates that can be crippling. Just when small businesses are supposed to be rapidly growing, they’re often tied up servicing their debt.

Crowdfunding has come in to fill the gap in the market, but it comes with a number of disadvantages. Most existing equity crowdfunding platforms focus solely on start-ups or early stage businesses in specific sectors (in particular technology and brewing), meaning that this new funding route is closed to most SMEs from other sectors. The majority of platforms also limit investor reach, resulting in incomplete raises and wasted potential.

Both equity crowdfunding and peer-to-peer lending, at least theoretically, have the most potential in solving the problems of SME financing - but the current system doesn’t work as efficiently as it could. That’s where blockchain comes in.

Blockchain helping SMEs to grow and thrive

Social lending has been a popular means of generating capital for hundreds of years (people who have money giving to people who need money), but it has fallen out of fashion alongside the rise of modern financial institutions. P2P is currently seen as something niche – something created for those businesses reluctant to trust the banks or incapable of securing funds from elsewhere.

With the advent of blockchain, P2P is likely to finally find its feet and move into the mainstream. The decentralized nature of blockchain circumvents the need for an intermediary, an attribute which could help revive peer-to-peer lending practices – digitising what was once a manual process.

The business fundraising process has traditionally been a complicated one, dominated by a handful of powerful banks. But blockchain naturally connects all parties on a system, so the customer would be linked directly to investors, with full transparency and a real-time view of finances on an immutable ledger. Through disintermediation, blockchain makes it significantly easier and faster for small and medium-sized companies – not just technology start-ups – to raise funds through equity.

The removal of these barriers reduces the need for complicated paperwork that has previously precluded many SMEs from engaging with banks. The automated nature of the whole process means that commissions, excessive brokerage fees associated with selling shares, and other overheads can all be slashed.

Importantly, the use of blockchain enables SMEs to sidestep the banks which, especially following the 2008 crash, have been acting more conservatively. Blockchain also opens up businesses to investors from all over the world, enabling both investors and start-ups to seize opportunities which had previously been closed to them.

What’s next for blockchain funding?

Blockchain has the potential to turn the SME funding system on its head. A blockchain-powered solution shows real potential for solving the SME funding problem once and for all: the archaic and inefficient system of bank business loans is ripe for disruption.

The biggest challenge, moving forward, will be the legality of smart contracts, and the worldwide regulatory framework that will be needed to implement true peer-to-peer lending which transcends borders: just because one country has declared it legal, does not make this so in the rest.

But people and companies across the business and political spectrums are recognising the power and potential of blockchain and smart contracts. It may take a while for regulators to catch up to the rapid pace of technological development, but once they do so, broader adoption will lead to sensible regulation and the creation of an environment where blockchain and SMEs can thrive.