Business lending is now the largest segment of peer-to-peer finance in the UK, but fierce competition for good-quality borrowers means the platforms have their work cut out. Peer2Peer Finance News delves into the industry’s plans to stay ahead of the pack
THE UK is often referred to as a national of entrepreneurs, or as Napoleon reportedly said, a nation of shopkeepers.
He meant this in a derogatory way, but the term has caught on.
Since the financial crash of 2008 many of those so-called shopkeepers have seen the doors closed
Successive governments have tried to tackle this with the Enterprise Finance Guarantee Scheme (where the government guarantees 75 per cent of a business loan) Funding for Lending (which let banks access cheap finance so they could then lend to small firms) and the British Business Bank, which is an umbrella body for several state-supported schemes investing in enterprises.
A private sector alternative has also emerged in the aftermath of the financial crash: peer-to-peer lenders.
Some of the biggest P2P business lenders, such as Funding Circle, ThinCats, Folk2Folk and MarketInvoice, had cumulatively lent out £4.4bn in total by the end of the third quarter. This is up from £2.5bn of cumulative lending by the end of the third quarter of 2016 and has boomed from just £661,954 first recorded in the third quarter of 2014.
P2P business lending volume in 2016 was equivalent to just over 15 per cent of all bank lending to small businesses, according to the latest UK Alternative Finance Industry Report by the Cambridge Centre for Alternative Finance.
This is up from 11.7 per cent in 2015 and just 0.9 per cent in 2012.
This is by no means a homogenous group, with P2P lenders providing everything from pure business loans to flexible working capital solutions.
Many of these firms, including Funding Circle and MarketInvoice, have support from institutions such as the British Business Bank.
Data from trade body the Federation of Small Businesses (FSB) shows P2P is becoming an increasingly viable solution, with its own research showing one in five applicants approached a P2P or crowdfunding platform in the third quarter of 2017 compared with one in 25 two years ago.
Brokers say firms value the speed and flexibility of P2P lenders in comparison to banks.
“Many P2P lenders are able to react quite quickly in providing finance as they operate under different credit policies to high street lenders,” Norman Chambers, managing director of the National Association of Commercial Finance Brokers (NACFB), says.
“From a credit perspective they have different viewpoints that sometimes aren’t quite as strict as banks.
“One common difference is that P2P technology is often more advanced than traditional banks and they are currently filling a void that some high street lenders haven’t been able to come back to since the 2008 crisis.”
A past criticism of P2P has been that they are just getting the borrowers that the bank rejects, which may be too risky or not creditworthy.
But this accusation is passionately rebuffed by P2P platforms.
“Rejected is too strong a word,” Angus Dent, chief executive of ArchOver, explains.
“Often the banks will provide smaller facilities than the business wants or needs, or facilities that simply don’t suit the business.
“Whether companies that opt for a P2P loan are creditworthy is a separate question. From what we see, the banks often try to fit all businesses in to a similar credit model without the flexibility, nimbleness or perhaps the desire to really understand the potential borrower’s needs, and to provide a loan that fits those needs.
“Unless you understand the business you’re going to lend to, you’ll always turn that business down at credit. It follows like night follows day. We work closely with an organisation to understand its business model and then monitor the business and its assets every month – a level of scrutiny you wouldn’t necessarily find with a traditional bank.”
Jordan Sanderson, business loans lead at MarketInvoice, says rather than the borrower being wrong for the bank, it is often the lender that isn’t appropriate.
“Business borrowers that turn to P2P for finance aren’t always the ones rejected by the banks,” he says.
“We know of many examples where a business would likely have been approved by a bank, but the lack of funding flexibility, such as an annual review of overdraft limits and general hassle of having to go into a bank branch, has driven them to pursue other options. Separately, ‘creditworthy’ could also mean a number of things.
“Our risk models, which amalgamate various data points, enable us to get comfortable with different profiles that more traditional lenders, with a black-and-white approach, may not be able to do.”
For some platforms, P2P is too loose a term.
Ravi Anand, managing director of ESF Capital, parent company of ThinCats, says the word P2P is misleading.
“Some of our lending is institutional and some is crowd,” he explains.
“P2P is a misused term. You can use it in consumer lending and small lending but when you are lending between £1m and £2m you have to take a lot of due diligence.
“Our credit team’s criteria is different to the banks. I’m not saying the banks are wrong, they may just not have the appetite to lend. A lot is due to the size of the firm.”
Size is an important factor in the P2P space, and it is often both the size of the business and the loan that dictates whether a small- and medium-sized enterprise (SME) considers this sector.
This is something Conrad Ford, chief executive of business finance aggregator Funding Options, has noticed.
Firms such as Funding Options provide a range of alternative sources of finance for borrowers. It is also part of the Bank Referral Scheme that mandates lenders to refer rejected borrowers to aggregators where they can see other finance options such as P2P.
“P2P is very strongly associated with large unsecured loans,” Ford explains.
“Generally speaking, the major banks won’t do unsecured lending above £50,000.
“What that means is you can get some large and creditworthy businesses that go beyond the bank threshold. Funding Circle is a particularly good player here.”
He says another issue is that many borrowers are disconnected with their bank.
“SMEs are quite angry about how they are treated and looked down on by banks,” Ford adds. “P2P speaks their language.”
However, this does not mean that getting borrowers is easy for a P2P platform.
Ford says one of the biggest hurdles for lenders is origination, which he claims only Funding Circle has managed to overcome.
As well as having first-to-market advantage, Funding Circle has recently invested in a £12m broadcast, tube and billboard marketing campaign. This has helped its loanbook grow to more than £3bn.
Other platforms admit that general awareness and loan origination are issues but have opted to build their brand through partnerships rather than TV campaigns.
ESF Capital’s Anand says partnerships through intermediaries, brokers and lawyers build trust. ThinCats appointed a series of origination managers across UK regions such as Scotland, the Midlands and the south west of England last year to build relationships with local advisers and brokers.
This is an approach shared by Growth Street, which offers a flexible finance product called Growthline that lets companies access capital when they need it. It focuses its network on London, Manchester, Birmingham and the Midlands where it believes there is the biggest funding gap and most prospects for growth.
It has partnerships with NACFB brokers and offers commission to introducers. It also sources leads through direct marketing, as well as finance aggregator app Bud.
“The mindset of most businesses is that the only source of finance is their bank,” Greg Carter, founder of Growth Street, explains.
“We find the best way is working with the trusted partners of that business such as brokers and accountants and make them aware that it exists.”
P2P isn’t the only alternative lender as there are plenty of established specialist finance providers for SMEs. Chambers says this creates a challenge for NACFB brokers when comparing P2P.
“One of the concerns is they are portrayed as a lender to everybody,” he says. “One of the challenges is comparing why they can lend to all sorts of causes whereas there are specialist funders who have specific expertise.
“A traditional funder may actually look at the type of product a business needs rather than a P2P lender just approving a loan request.”
There is also further competition from banks entering the direct lending space, such as the Esme Loans venture from NatWest.
Archover’s Dent insists there is space for everyone. “Even after a few days’ travelling, on my return to the office enough new business had come up in three working days to keep us busy through the next two months, and that’s assuming that the pipeline wasn’t already full to bursting, which it is,” he says.
However, one area that commentators including Ford and Anand highlighted as saturated was invoice financing as there are a lot of specialist funders and banks working in this area.
This may explain MarketInvoice’s recent move into business loans, although the platform insists invoice finance remains its core offering.
“We are positioned as a business finance company and our platform is how we deliver our business solutions,” Sanderson says.
“Our offering has always stood out for its ease of use, speed of funding decisions, and a world-class customer service team. Underpinning all of this is our motivation to enable business owners to focus on their companies.”
All of this lender interest is backed up by institutional support both from funds and the government in the form of the British Business Bank. The Autumn Budget also unveiled a £20bn action plan to fund start-ups.
The support for SME borrowing contrasts to the personal loans market where there are fears of a consumer debt bubble, so could small firms get caught up in a business loans crash?
Both the FSB and the NACFB warn that Brexit and the withdrawal of European Investment Bank funding may tighten the credit market.
But Ford points out that the lending environment is nowhere near bubble territory.
Bank of England data shows loan approvals to SMEs were up just 0.5 per cent annually in October, compared to a peak of around 15 per cent almost a decade ago just before the financial crash.
There is a long way to go to get back to the pre-crash SME borrowing levels, but another criticism levelled at P2P is that platforms have not been through an economic cycle.
Funding Circle put this to the test last November by seeing how a loan portfolio would perform under Prudential Regulation Authority-style stress testing in an experiment independently verified by financial consultancy True North Partners.
The platform simulated how two example portfolios paying 6.7 per cent and 6.8 per cent respectively would perform in a severe recession similar to 2007/08, and found they would still return around five per cent.
For now it seems P2P lenders are a vital part of keeping the door open to finance to help this nation of shopkeepers grow, whether Napoleon likes it or not.
This article featured in the January edition of Peer2Peer Finance News, now available to read online.