It’s no secret that banks are failing to adequately support the small business community. Indeed, last month at MADE: the entrepreneur festival, business secretary Vince Cable acknowledged the difficulties businesses were having in raising funding. “It is a difficult environment and we in government are trying to help… We need more competition. We need more banks,” he said.
But perhaps it isn’t banks we need at all. For the gap that the financial services sector has left yawning open is rapidly being filled by alternative financiers. From crowdfunders, where experienced investors inject cash into start-ups in return for equity, to peer-to-peer lending, which caters to more established businesses, the market is abuzz with innovative new finance solutions.
Funding Circle falls into the latter category. Founded in August 2010 by University of Oxford graduates Samir Desai, James Meekings and Andrew Mullinger, Funding Circle matches investors with small- and medium-sized enterprises that need to borrow money. At the time of going to press, Funding Circle had lent close to £52m to around 1,000 businesses in the UK. And the average age of a business on the site is 10 years old – these are no whippersnappers.
Growth has been rapid from the beginning, but has really begun to ramp up in recent months, especially among investors, says co-founder James Meekings: “We’ve had a big uptake in the number of people who are joining to lend to businesses possibly as a result of some of the issues with the banks, whether it’s the Libor scandals, the IT glitches, or other problems,” he explains. “I think people are starting to ask, ‘Where else can I put my money now outside the bank?’”
That was certainly one of the questions going through the mind of marketing executive and Funding Circle investor Daniela Sheppard in late 2010. “I have a portfolio which is made up of various products and services,” she explains. “I like to be hands-on with where my money goes and try to make the most of is. This can be a challenge because the market hasn’t been good to us investors in the past few years.”
Sheppard began her Funding Circle investment career with just a few hundred pounds, but gradually increased the amount and her current investment in the platform stands at around £10,000. This is a pattern Meekings has seen replicated many times. “Once someone joins and puts a small amount of money in, they usually increase their subsequent lending,” he says.
This behaviour is often as a result of increased trust on the part of the investor, says Meekings. “I think it helps to have people who have been fully paid back,” he admits. But he also says it’s important that potential investors appreciate the risks before parting with their cash: “I also think it helps to have businesses that haven’t paid back because people can actually see the risk and understand it, rather than us just explaining that they can expect some bad debts and giving them our rate, which is about 1%. They need to be able to quantify the risk.”
It goes without saying that a huge amount of work goes into assessing each company and giving them a risk grade, with ‘A’ being the lowest risk. The process can be a little intimidating – but nowhere near as arduous as dealing with a bank, says Richard Curtis of independent coffee shop Ground Coffee, which borrowed £40,000 in 2011 and another £50,000 in 2012.“We had to provide P&L statements, balance sheets and so on. Then they gave us our risk assessment grade, which was presented to the lenders on the website,” Curtis explains.
Ground Coffee’s first request was fulfilled in just eight hours, with the second loan taking a couple of weeks. The company was also subjected to a slightly more rigorous line of questioning the second time round, too. “The first time no-one really asked us any questions using the Q&A facility on the site, but the second time around they had loads. It was quite challenging actually, because you’ve got really serious investors on there asking accountancy questions, which could be quite tricky to answer,” he explains. “There were other operational queries that we were more familiar and comfortable with about how the business is run. It was a good balance.”
Meekings says that it is often the case that investors are a little more inquisitive if a company goes back for a second round of investment. He also says that as the platform has developed, there is now a greater level of engagement between investors and businesses. Which can be good for all involved: “Some of the businesses have said it’s been really helpful getting the questions from investors because it’s made them think about some of their business issues,” he says.
As time-consuming as answering questions from investors may be, it always pays off: not a single business that’s listed on Funding Circle has failed to raise the finance it required. And not only is it cheaper to borrow through Funding Circle, with substantially lower interest rates than the banks, the set-up fees are a fraction of the charges associated with borrowing from a bank – Funding Circle charges 1% commission.
But it’s not just the lower costs. It is also speed – a bank loan can take four months to process – and an overall shift in mindset that makes peer-to-peer lending an attractive option. “In terms of lending to the SME market, the banks are still stuck where they were 50 years ago and they haven’t learned they need to change,” says Jeff Pert, general manager of the Cashmere Centre (see case study).
Funding Circle’s model also allows for flexibility in a way that the staid old banking model of yesteryear is unable to. Meekings says that 50% of applications are made on Funding Circle’s website outside of office hours. “That would tell me that they don’t want to go into a bank and would rather do it in the evenings, maybe after they’ve had dinner or put the kids to bed,” he adds.
This isn’t to say that banking won’t recover to some degree, and over the next few years the banks are likely to develop new takes on old investment products. Though it may be a case of too little too late, says Meekings. “What’ll happen over that period is that people will start to use alternatives, and they will start to enjoy those different processes and won’t want to go back to the bank.”
He may well be right. And on the flipside, perhaps by the time banks feel they have recovered adequately to ramp up their lending to small businesses once more, their services will no longer be required. The market will have changed irrevocably.
You snooze you lose, as they say.
The Cashmere Centre
Two years ago we were looking for finance to fund our stock for the peak season. With my background as a commercial banker for Lloyds TSB, I knew how to put together a business plan, which we then submitted to five high-street banks. All five of them said yes, they liked the plan and wanted to help. We had initial meetings with the account managers who came out to see of us.
Of those five, we never had any further contact with two of them, despite chasing them. They just didn’t want to respond. Two of the others came back and said, we’ll offer you finance, but it’s subject to directors’ guarantees supported by their houses. At that time, one of the shareholders was living in Spain and didn’t have property in the UK, so all of the responsibility would have fallen on the other shareholder. And we weren’t prepared to do that.
Around this time, I read about Funding Circle in an article and decided to go down that route. It took me a day to put together the information they needed and it was on the site within a couple of days. Within 14 days we had the £40,000 loan we’d requested.
The banks are still stuffed full of toxic loans, so effectively they don’t want to loan. One issue is they’re still geared up to the 1950s when the branch manager only dealt with local businesses. Also, in my opinion, taking a director’s house for security is the wrong way to go nowadays. It may have been appropriate 50 years ago but it isn’t now.
The banks don’t see how outmoded they are, or that they need to change. For commercial lending, I think more and more people will go to peer-to-peer lenders such as Funding Circle.