Peer to peer lending - is it the answer?

David Newton, head of Birmingham office, ArchOver, looks at the funding options for SMEs across the Midlands:

You are based in the Midlands and you own or run a business that has been successful for a few years. You ask yourself, “how do I grow my business?”

The natural reaction for many is to think of the financial constraints imposed on the business, often cash constraints caused by the negative attitude of the banks to SMEs in general, and the resultant diminishing of bank finance and overdraft facilities. This is a natural response, borne out in part by the financial crisis of 2008, which led to the retrenchment of the banks as they made a whole generation of SME specialists redundant and the flight of lenders to perceived safer assets.

The world has moved on. The UK is well known for its entrepreneurial approach to financial services – it has always been a global finance provider, seeking to invest and fund businesses in new geographic markets and business sectors – and the last decade has been no different.

As the banks turned their backs on SMEs and introduced a “computer says no” attitude, a new class of lenders materialised in the form of Peer-to-Peer Lenders (P2P) adopting a best of breed approach by reverting to face to face meetings with clients, a desire to understand their business needs, all supported by modern technology, systems and processes. Consequently, the sector has flourished to the point that it is now a major source of finance for the UK economy.

What is a P2P Lender?

There are two aspects to a P2P lender – firstly the borrower, normally an SME, which is seeking finance. This could be a mortgage secured against property, ABL finance, the replacement of an existing overdraft and/or lending facilities or new working capital facilities to fund growth.

The other aspect is the lender, which is often an individual investing a portion of their savings; such lenders seeking a financial return of typically between 6-12% on secured business assets - banks have not helped themselves by the way they treat depositors. Savers are well aware that when the base rate goes up, the deposit rate rarely follows and the banks gain a bigger profit margin as a result.

Too often, new finance businesses have focused solely on obtaining institutional investors as the volume of cash at an institution’s disposal dwarfs that available from the retail market, but now there is a finance sector that wouldn’t exist without its retail investors – democracy in finance. It is not a new concept – the Lloyds insurance market is a good example of this retail involvement, what is new is the intelligent application of 21^st century technology.

In the past, P2P lenders have been very much London-centric, but increasingly they are expanding their influence throughout the UK. ArchOver has reflected this by opening its first regional office in Birmingham. More will follow to the benefit of UK Plc as a whole. This is a trend being replicated by other P2P lenders in an industry that is flourishing and set to stay.

The decline of the Old Order

Traditional banks are being replaced by agile, technology-driven funding providers. In the past, a Midlands-based SME would turn to its bank to help with its funding and cash flow needs. It would be a no-brainer to approach your relationship manager and the relevant overdraft, loan or ABL facility would often follow, but since 2008 the computer is most likely to say “no”, especially if your business profits are less than approximately £3 million. In the wake of the collapse of Lehmann’s and given the need to restructure the various banks’ balance sheets, these facilities were often reviewed and, in many cases, withdrawn, which in turn led to a funding crisis, especially for SMEs.

This approach has, however, left the market open to new entrants. Challenger banks, such as Metro Bank, were introduced to great fanfare and made a play for firstly the retail market, and more recently in the commercial property and ABL sectors.

Equity crowdfunding was introduced through the likes of Crowdcube and Seedrs and the P2P lending sector was developed with the launch of companies like Funding Circle and ArchOver. Financial markets have developed.

The P2P product – entrepreneurial flair is creating product variety and choice for borrowers

Each P2P lender has its own set of finance solutions that makes it attractive to a borrower. Some P2P lenders, such as Funding Circle, are happy to advance finance secured against personal guarantees provided by the directors and major shareholders of a company, whereas some, such as ArchOver, make it a USP that a personal guarantee will never be asked for and instead seek to secure their lending solely against business assets. Some P2P lenders will lend against property, others against trade receivables or contracted recurring revenue.

The rates charged by P2P lenders are competitive. It is important to understand that this sector is not the ‘Wonga’ of the business world; we are not talking about payday loans. The lenders that operate in this sector are professional firms seeking to provide a successful lending experience to quality and profitable businesses.  

Improvements in regulation leads to greater investor confidence

Given that the P2P lending sector, and indeed the crowdfunding sector in general, did not exist ten years ago, it is no surprise that it has taken the Financial Conduct Authority (FCA) time to catch up with market developments and introduce the rules required to protect the various market participants.

Investment rules for equity crowdfunding businesses are now in place and govern how investment opportunities may be marketed to retail investors and a consultation paper on the proposed rules for the P2P lending sector has recently been published by the FCA for implementation, most probably, in 2019.

P2P lenders are authorised and regulated by the FCA and the proposed regulations will assist the sector in a wholesale ‘flight to quality’ which will help protect lenders and borrowers alike. The most successful P2P lenders will be those that embrace these regulatory changes and seek to offer an attractive product to quality borrowers, whilst protecting lenders investments and maximising their returns.

The future

SMEs are increasingly getting access to the finance they require and the funding prospects for SMEs in the Midlands are looking increasingly good. The P2P sector is providing options not previously available to the businesses that are the backbone to the local economy. Businesses in almost all sectors can now secure funding ranging from traditional manufacturers through to engineering companies and even those that are perceived to be asset-light such as software companies and even serviced office providers. These P2P lenders now have a local presence with local investors and lenders and are actively seeking out Midlands-based businesses to lend to.

In turn, P2P lending has a bright future. Unlike the banks, companies like ArchOver have the agility and entrepreneurial leadership to evolve their business models and adapt to changing market and regulatory conditions, without losing sight of their core values. That flexibility will benefit both lenders and borrower companies. It’s onwards and upwards for the SME sector.