Open for business

Business lending is one of the most celebrated segments of the peer-to-peer finance industry, providing much-needed funding for smaller firms that, in turn, support the UK economy. But how will platforms maintain their edge in a competitive market? Emily Perryman reports

PEER-TO-PEER BUSINESS lenders have become an important lifeline for the UK’s smaller businesses, in part due to their willingness to step in and lend where traditional banks won’t.

In 2018, nearly £2.3bn was lent to UK businesses through P2P business lenders – significantly higher than the £1.8bn of consumer P2P lending done over the same period and an increase of 18 per cent on 2017, according to an analysis by the British Business Bank.

Yet the market isn’t without its challenges. Finding borrowers is an extremely competitive process and achieving scale has become crucial as fears of an economic downturn intensify.

One of the ways lenders are adapting to the tougher environment is by trying to differentiate themselves from other players in the sector – whether that’s through the types of businesses they back, the size and style of loan they offer, or innovations in their underwriting process. Variety in the market means the sector not only meets the needs of a range of business borrowers, but also provides choice for investors.

Risk-return profile

For investors, the P2P business lending sector represents an attractive way to back British businesses while benefitting from inflation-busting returns.

Advertised returns are usually lower than in the riskier property development finance sector, but higher than in consumer P2P lending, which reflects the fact that small- and medium-sized enterprise (SME) loan default rates tend to be greater than consumer loan default rates.

“If people are in financial difficulty they tend to sort themselves out, for example they might work part time,” explains Stuart Law, chief executive of Assetz Capital.

“Businesses, on the other hand, reach a cliff-edge and it’s more common for them to completely shut down.”

The vast majority of SME loans are unsecured, although some platforms, including Assetz Capital, LendingCrowd and Folk2Folk, do offer security in the form of charges over property or other assets.

A spokesperson for Funding Circle, which offers unsecured loans with a personal guarantee, says the platform reduces risk for investors by only lending to well-established companies who have been operating for an average of 10 years. “On the investor side, we are delivering attractive returns of four to seven per cent a year, and investors have earned a total of £300m in interest (after fees and bad debt),” the spokesperson said.

Read more: SMEs unaware of the risk of personal guarantees for business loans

Finding borrowers

For big names like Funding Circle, many borrowers come directly to the platform, but other lenders are seeking out alternative ways to attract borrowers.

“Enticing borrowers is competitive in this space and different platforms cope in different ways: cold-calling profitable businesses; contacting potential borrowers in their own networks; online and traditional advertising; loan comparison sites; customer referrals; referrals from platforms’ parent companies; regional offices; and receiving offers from partner lending businesses to lend to the same borrower,” says Neil Faulkner, managing director of P2P comparison site 4th Way.

Some platforms are making use of online business lending aggregator sites. Katrin Herrling, chief executive and co-founder of online marketplace Funding Xchange, claims borrowers who use the site will get an offer within three minutes, while lenders will have access to pre-qualified customers thereby ensuring higher closing rates.

Aggregator sites are mainly targeted at small businesses – 98 per cent of the loans provided via Funding Xchange are below £150,000, reflecting the fact that most borrowers have a turnover of less than £1m.

“The traditional broker relationship is becoming less viable for loans of less than £150,000 because the ability to charge fees on top is difficult,” says Herrling. “Borrowers who come through us don’t pay any more than if they went direct to the lender.”

Assetz Capital, on the other hand, which offers loans of up to £10m, gets 80 per cent of its business through brokers. “There is a theory that forming relationships with accountancy firms works, but it doesn’t,” says Law. “It’s not their job to sell loans and so it is a very relaxed, ad hoc referral method. A broker’s job is to serve lenders and they maximise their day selling loans.”

It was hoped the government’s bank referral scheme would boost the number of SME borrowers but the figures suggest otherwise. Since November 2016, almost 30,000 small businesses that were rejected by big banks have been referred to the scheme, but as of the end of June  2019 only 1,700 of those have secured funding, with an average loan value of less than £20,000.

Angus Dent, chief executive of ArchOver, argues that the scheme was “a complete and utter waste of time and effort for all concerned.”

Read more: MarketInvoice: Cash flow headaches slow growth of 87pc of UK SMEs

Embracing technology

Many platforms are turning to technology to attract borrowers, make the lending process smoother to better compete  with other players.

Julien Tavener, chief operating officer at online lender aggregator Alternative Business Funding (ABF), says technology is changing the relationship between finance providers and businesses from a purely responsive, provider one into a proactive and more advisory one.

“Open Banking and cloud accounting access allows finance partners to refine their automated acceptance processes, leading to a dramatic reduction in time and friction,” he says. “In turn, the visibility of up-to-the-minute transactional information allows finance providers and others to tailor products to meet needs in a more predictive manner, allowing them to ‘get in front’ of the SME requirement and serve live quotes and other information.”

Greg Carter, founder and chief executive of Growth Street, claims technology such as Open Banking and cloud accounting has dramatically increased the efficiency of the platform’s credit analysis.

Growth Street has created an overdraft-style product and recently became the first overdraftstyle finance provider on the marketplaces of cloud accounting platform Xero and Starling Bank.

“This is an API-based integration which means when a firm connects their Xero account they can share their financial information with us at the click of a button and soon will be able to manage their facility entirely from Xero, such as requesting a drawdown and making a repayment,” Carter says.

Growth Street recently slashed almost a third of its workforce and has now pivoted its origination strategy away from a ‘boots-on-the-ground’ approach, focusing instead on its Xero and Starling Bank partnerships.

Some lenders, however, are less enthusiastic about the benefits of technology, arguing that human input is still required.

“Developments such as Open Banking, APIs and data feeds are welcome, but it’s important to remember that many borrowers still value the personal approach,” says Stuart Lunn, founder and chief executive of LendingCrowd. “At LendingCrowd, a human always makes the final lending decision, based on the risk-band modelling tools that we developed in-house. At a time when the banks continue to scale back their physical presence, we have also expanded our business development team so we can meet potential borrowers face to face and support them with empathy and care.”

Read more: A sense of security

Looking ahead

With an economic downturn potentially on the horizon, many industry onlookers think the P2P business lending sector will see some consolidation, particularly given its competitive nature.

Herrling says many lenders have failed to successfully scale and that the costs of doing business are simply too high to make it viable.

“There are also questions around which P2P lenders have viable risk models that will survive a full economic cycle,” she warns.

A spokesperson for Folk2Folk says the platform, which focuses on providing finance to rural businesses, is always mindful of external influences that could undermine lenders’ investments such as falling interest rates, sector stability and the current political environment.

“Due to the secured nature of our business, a key area we monitor is a fall in property asset values and we look at this on a sector and portfolio basis to ensure that our ongoing risk management framework is appropriate and allows us to mitigate against falling values over the term of any loan,” the spokesperson adds.

For the sector as a whole, most platforms feel positive about its future. They argue that in an economic downturn the traditional banks’ model is to pull back on lending, whereas the P2P sector should be able to ramp up lending once the worst of the recession has passed.

“The outlook for alternative finance providers, and P2P lenders in particular, looks strong,” says Tavener. “The mood music from the large, traditional lenders is that the SME market remains a danger area for them and although they won’t exit it entirely, it is probable that they will continue to adjust their exposure to this market by gently tightening credit conditions.

“There is a strong, emotional simplicity to P2P funding. Investors take part in supporting UK ltd and achieving an uplifted yield in return. There will, of course, be ups and downs on this journey, however we believe that not only is P2P here to stay, but it will ultimately be seen as a major contributor to a vibrant and innovative economy.”