The recession may be behind us but online finance platforms only look set to become more popular among SMEs, claims Clive Lewis, head of enterprise at ICAEW
Peer-to-peer lending platforms – which bypass banks and allow anyone with a bank account to lend money directly to one or more people – make up a small amount of the UK business debt market. But they are set to shake up UK business lending to smaller companies.
Online sources of finance include debt funding, equity finance and working capital funding such as factoring and invoice discounting. Whichever type of online finance you choose, the basic model is the same: they seek to match businesses looking for finance with individuals and businesses looking for diversification of risk and yield. However, business models vary. For many online finance providers, the cost is proportionately higher than bank finance but the risk is often greater, although peer-to-peer lenders have, to date, had relatively low failure rates on advances.
Business debt finance
For debt finance, applicants fill in an online application form. The platform’s credit assessment team will evaluate the application and respond in a few days. Acceptance criteria will vary according to the platform chosen, but platforms’ preference is for solvent businesses with a trading history. Full particulars of existing loans and commitments will be required. The online provider applies a risk rating to assist lenders in assessing the risk of not getting their money back. Once accepted for entry, loan applicants enter the auction.
In the auction, the registered lenders start bidding the amount they are prepared to lend and the interest rate they expect to be paid. As bidding intensifies, the interest rate can drop. Applicants can accept the loan as soon as it is fully funded. Alternatively, they can wait longer and see if the average interest rate payable drops further. Once the loan has been accepted, applicants can expect the money to be in their bank accounts within a few days. The internet platform deducts the arrangement fee – either a percentage of the loan or a fixed amount. The applicant repays the loan to the lending platform, which is responsible for distributing the repayments to all individual lenders involved in the loan.
Equity finance through the internet
Businesses seeking equity finance must complete a questionnaire specifying how much finance is required and the equity on offer. The disclosures are reviewed by the platform to ensure they are fair, clear and not misleading. The platform then approves the listing.
Investors can invest from £10 up to the full amount required. If the applicant business receives offers up to the full amount within a specified period, the offer goes to closing. If not, any investors who offered money get their money re-credited to their account. In closing, legal due diligence is conducted and the business signs documentation and the online platform subscribes for shares on behalf of investors. The platform charges a fee for obtaining finance to the business out of the proceeds of the share issue.
Other finance available through the internet
Factoring and invoice discounting are available on business-to-business sales only – and the sales invoices used must relate to customers with a good credit rating. Online platforms can be more flexible than conventional lenders and will consider financing individual sales invoices rather than the whole sales ledger.
There are also an increasing number of finance providers prepared to offer loans to retail businesses based on their future credit card income. The platform agrees to buy future credit card receivables at a discount. Once accepted, the finance is provided and daily repayments are made via a small fixed percentage of credit card sales, with loans usually repaid in six months.
Finally, there are platforms offering to help businesses with electronic invoicing, automatic updating of debtor listings and cashflow forecasts, as well as arranging finance based on the debtor book.
Perhaps the most significant recent development in internet finance was eBay’s announcement that it intends to offer small business loans to its PayPal customers. Other technology companies are getting in on the act so it’s very much a case of watch this space over the coming months.