THE BIG GUNS IN peer-to-peer small- and medium-sized enterprise (SME) lending have been pretty successful at opening up the price and availability of both secured and unsecured loans over the past decade or so. Now, says Greg Carter, chief executive and founder of SME lending platform Growth Street, it’s time for a new generation of P2P innovators to do the same thing for the lesser-spotted business overdraft.
Also known as revolving credit facilities, the supply of small business overdrafts from mainstream banks dried up almost overnight after the financial crisis and has not recovered since, according to Carter.
“There is a huge gap in the availability of overdraft finance,” he asserts. “Since the financial crisis, the availability of overdrafts for SMEs has actually fallen by 43 per cent, at a time when the SME population has actually grown by over 30 per cent.”
It amounts to an £18bn shortfall, he adds, and despite the rise of cheaper, faster SME loans from the likes of Funding Circle and its growing crop of rivals, flexible credit is still largely provided by banks.
“The gap hasn’t been filled by any other products, there’s been a real lack of innovation in the availability of flexible credit for SMEs,” he adds.
In a bid to do something about it, Carter founded Growth Street in 2014. “I saw an opportunity, and a couple of trends that would enable us to serve it,” he explains. “Firstly technology – there was more and more data available from SMEs that were using cloud accounting tools like Xero, and they were also increasingly happy to share that data through the APIs that those tools have.”
Slick technology would not only eliminate the hassle for customers of having to find and send paper statements and PDFs as part of the application process, it would also enable Growth Street to dramatically reduce the cost and increase the efficiency of credit analysis, he says.
“Then there was a regulatory trend – P2P was reaching maturity and had just started to be regulated, and it was clearly a very flexible source of funding for the business. And there was the Open Banking trend, which would give us even more extremely valuable data.”
Growth Street’s core product – known as Growth Line – is a revolving credit facility with a limit of between £25,000 and £2m. Approval varies depending on the size and nature of the business applying but typically takes between one to three days, says Carter.
Once approved, borrowers can draw down and repay any sum up to their limit as often as they wish. There is a service fee, and interest which depends on credit risk, but overall costs are comparable to the regular banks, he says, and availability is much better.
“If you could get a bank overdraft it would cost a similar amount,” states Carter. “Compared to a Barclay’s business overdraft the cost is pretty much the same.
“It’s a very flexible revolving facility that gives businesses complete control over cashflow. They can stop worrying about unexpected costs and just get on with growing.”
For investors the platform also offers advantages over regular term lending, says Carter. When a Growth Line customer draws a sum down, a 30-day loan contract is created automatically and matched with available investors’ funds. Although many people prefer to roll over their investments for continuous returns, the fact that each contract is only for 30 days should make it easier to get your money out than it is from a three-year term loan.
“It’s a stable liquid investment,” Carter says. “Under normal liquidity conditions investors can withdraw within 30 days.”
Returns, he says, are around five per cent on an effective basis, and the firm has just launched an Innovative Finance ISA offering 5.8 per cent for those investors wishing to commit their funds for a year rather than 30 days.
“It’s early days for the ISA but take up is good so far,” he reveals. “We launched early in the year so that we would be fully operational for the ISA season later in the year.”
After a degree in neuroscience specialising in gambling behaviour, Carter joined online gambling platform Betfair before moving into venture capital at Arts Alliance – an early investor in the likes of Graze, Shazam and LoveFilm – following Betfair’s £1.4bn stock market flotation in 2010. In both roles he witnessed both the transformative power of new business ideas, and the growing pains that accompany them.
“At Betfair I was in charge of new ventures, and I got hooked on how businesses grow,” he explains. “At Arts Alliance I would ask the companies I was working with what was holding them back from growth. The answer that came up most often was managing cashflow.”
The crux of the matter, the entrepreneurs explained to Carter, was that because their cashflow was so unpredictable they had to hold large cash reserves in order to be able to cover unexpected costs. Cash that could much more profitably be put to work in growing the business.
“What they really wanted was an overdraft, but it would take their bank six months to say no,” Carter comments. “It was incredibly frustrating for them.”
Happily for Carter, Arts Alliance’s founder – and Growth Street’s lead investor – Thomas Hoegh didn’t take too much persuading that the firm’s concept of “the overdraft, transformed” had legs.
“He had already been thinking about disrupting banks,” Carter says. “His years as an investor and entrepreneur had taught him that banks were completely useless at providing growth finance for SMEs.”
Carter concedes that there are valid reasons why banks struggle to service small businesses – the differing regulatory capital requirements make mortgages, for example, a much more appetising prospect than financing SMEs – but also admits that he was surprised to discover for himself just how difficult they could make life for a start-up with an untested business idea.
“Until challenger banks like Metro and Starling came along it was impossible,” he asserts. “One of the biggest challenges we had in 2014 was that we couldn’t get a bank account. We went to lots of banks and told them the business we were building and they just said flat out ‘no’, it was extraordinary.”
But even this unexpected cloud had a silver lining – Growth Street got an account in the end, but not before it had been forced down a DIY route which involved building its own automated e-money payments system. “It was very frustrating at the time but now I am grateful for it, because we were
forced to innovate, and that system is now one of our secret weapons.”
Growth Street – which in January closed its first equity funding round, raising £7.5m led by the Merian Chrysalis fund – is also innovative in the way it tackles two other major issues that make revolving credit more complex to provide than term lending – underwriting and liquidity management.
Read more: Growth Street has lent out more than £500m
For overdrafts as opposed to regular loans, credit risk assessment is not a one-off but rather an ongoing process.
“We spent a lot of time early on looking at how we could use data not only to approve facilities up front but also to continuously monitor them,” Carter says.
“Since early 2017 we have had a partnership with Moody’s Analytics using one of their core products called Risk Calculator. We grade customer using data that we pull continuously from their cloud accounting platforms.”
The average credit facility Growth Street provides is around £200,000, and liquidity is a challenge because of the uncertainty over when and how much of their limit any customer will be using at a given point in time.
“We have invested in our own exchange technology to manage that problem, inspired by my time at Betfair,” he says. “We have to ensure that borrowers can always draw down, and that investors’
funds are always deployed, that’s the real balancing act.”
Investors effectively join a queue to be matched with 30-day loan contracts, so the volume and frequency of matches on the platform is considerable – “Hundreds of millions a year,” says Carter. To manage any blips in supply and demand, Growth Street has deals with a small number of institutional investors – typically family offices – which act as a backstop on the platform to ensure liquidity.
“They are not matched very often so we pay them a standby fee,” he explains. “It helps to ensure that our deployment rates [for retail investors] are in the high 90s in percentage terms.”
It all seems to work – Growth Street has signed up 2,500 investors since it opened for business and has lent out around £96m to SMEs over the same period. The average investment is £16,000, and 40 per cent of those on the platform are millennials, which as Carter points out rather goes against the prevailing narrative that younger generations don’t save.“On our platform they are the single biggest group,” he says.
Growth Street also happily anticipated the Financial Conduct Authority’s ruling that investors should self-certify, and has categorised its lenders as retail, high-net-worth or sophisticated from the outset.
The sophisticated and high-net-worth categories account for around a third of investors by number, but around two thirds of funding. The rest (including that large millennial cohort) are retail investors, with average investments of £4,600 each.
One unanticipated development, says Carter, is that more established cash-rich businesses are now
starting to lend their own surpluses to younger, faster-growing firms via the platform.
“Companies invest their surplus cash and they appreciate the flexibility – they cycle up and down according to the seasonal cash demands of their own business,” he explains.
“It’s underappreciated that SMEs are actually net depositors. There is £130bn of SME borrowing in
the UK, and £150bn of deposits. But those cash reserves are not evenly distributed.”
Growth Street’s own business is growing fast, and it has just launched into the Scottish market, which Carter describes as having “a beautiful population of SMEs that are hugely underserved by
the big banks. There’s an £800m overdraft gap there, one of the biggest in the UK.”
Although he intends to prioritise overdraft alternatives while developing a substantial data asset
that could be used to sell a range of financial products to SMEs, Growth Street is not all about the
numbers, he adds.
“We want to be a leader in the way we support our clients, not just investing in the best tech but also in strong relationship management,” says Carter. “That’s why we have built a fantastic team of relationship managers. We have a view that a borrower is not just a single transaction but an ongoing relationship – and we plan to be here to grow and scale alongside them.”
This story first appeared in the print issue of Peer2Peer Finance News, which can be read in full here.