The Small Business Data Conundrum (Part 3):  FICO

"Not everything that can be counted counts, and not everything that counts can be counted." – William Bruce Cameron

When we think about credit scores, we immediately think of the FICO score—the gold standard for assessing consumer creditworthiness. FICO scores work well for individuals because they rely on clear, consistent data about personal credit usage. But applying this framework to small businesses? That’s where things get murky. Let’s explore why.

Why the Consumer FICO Works

The beauty of the FICO score lies in its simplicity and predictive power. It is designed to predict one thing: how likely a consumer is to repay their debts on time. What’s remarkable is that the FICO model doesn’t require direct knowledge of an individual’s income, expenses, or total wealth to make these predictions. Instead, it relies entirely on past behavior and a few straightforward metrics:

• Payment History: The single most important factor, showing whether you pay your bills on time.

• Credit Utilization: The ratio of your current balances to your credit limits, which indicates how much credit you are actively using.

• Length of Credit History: How long you’ve had credit accounts, which helps establish a track record.

• Types of Credit Used: A mix of credit types (e.g., credit cards, auto loans, mortgages) shows experience managing various forms of credit.

• Recent Inquiries: Too many recent requests for credit can signal financial stress.

These metrics work because consumer credit behavior is relatively consistent across large populations. Most consumers operate within similar financial frameworks—they earn wages, use credit, and repay debts in predictable ways. The FICO model’s reliance on past behavior to predict future behavior is both elegant and effective.

But Doesn’t My Lack of Credit Usage Show I’m More Responsible?

This is a common refrain you might hear from people who don’t exist in the credit ecosystem when they go to make a major financing decision only to learn their lack of a FICO is a major problem. From their perspective, they managed to live within their means for decades, so shouldn’t that be a better indication of their ability to manage money than someone who constantly needed a loan to make ends meet?

But there are two answers to that question:

1. The Empirical Answer: FICO scores empirically work and are incredibly effective across a wide swath of the population with minimal cost to the lender. Dealing with corner cases is expensive and simply not worth it. Many lenders would rather turn away excellent candidates who don’t fit within their standard boxes because it isn’t financially viable to develop the necessary tools to underwrite them properly. Moreover, lenders exist in a complex ecosystem of other financial institutions and regulators where exceptions to the overall policy need to be repeatedly justified. Simply put, the effort isn’t worth it.

2. The Cynical Answer: Lack of credit usage weakens the key lever lenders have to get a borrower to repay. Fundamentally, when you take out a loan and spend it, the money is gone, and lenders have few options to recover it. Their biggest lever is penalizing you from accessing more credit in the future by marking your credit file. If you don’t use credit and suddenly take out a large loan, lenders perceive you have little to lose by not paying it back.

The Fundamental Misfit

Now it should become more obvious why this doesn’t work in the small business space. The reasons consumer FICO works actually cut against the usefulness of a small business FICO equivalent:

• Data Fragmentation: Whereas consumer loans are neatly filed and categorized in credit bureaus, small business loans are not. Many exist as trade credit relationships between businesses, reported inconsistently (if at all) across multiple banks, credit unions, and bureaus. This lack of standardized reporting makes it difficult to build a cohesive credit history.

• Limited Incentive to Build Credit: A consumer who defaults on a loan remains tied to their credit score for years and has an incentive to rebuild it. Small businesses, however, often cease to exist after defaulting. This capped downside creates stronger incentives for risk-taking, especially without personal guarantees.

Final Thoughts

The notion of a small business FICO score is appealing for its simplicity, but it oversimplifies a complex reality. Small businesses are as unique as the entrepreneurs who run them, and a one-size-fits-all scoring system will always fall short. Instead, we should strive for evaluation tools that respect the nuances of small business operations, providing insights that are as dynamic as the businesses themselves.

By acknowledging these differences, lenders and stakeholders can make smarter decisions—and small businesses can thrive without being unfairly penalized by metrics that don’t make sense.