Small Business

Five Tips for Peer-to-Peer Borrowers

It’s not about the rate.

P2P is not (yet) about beating the interest rate you would pay if you went to the bank. If you bank has agreed to your loan request, snap their hand off – you’re lucky to have got an offer. Generally, the banks will always be cheaper, even if they have more onerous terms and take longer to agree and then pay out the loan. P2P is about availability of funding, speed of decision and flexibility of proposal.

 

Be prepared to give a personal guarantee.

This applies to most lending, including from banks. P2P is not about unsecured borrowing and you should expect to give a PG to cover your company’s borrowing. The only exceptions are when there is an exceptionally strong security package. There are some platforms that will look at lending without PGs, but the proposal has to be very strong.

 

Don’t try and play platforms against each other.

The investor base behind P2P comprises essentially of one large group of retail investors who will spread their investments over a number of platforms. If the same proposal appears on a platform after failing to attract investment on another, then investors will ask pointed questions, and if it looks as though you are hawking a deal around each platform, reputation quickly becomes tarnished. Best practice here is to change the terms of the deal before trying again.

 

Be prepared for full disclosure.

And make sure your company’s public image is right. Many retail investors see this as a hobby as well as a shrewd investment, and have lots of time to trawl the internet and other sources for background information. If you are a restaurant or hotel, pay attention to your TripAdvisor ratings; If you’re a manufacturer, make sure your Credit Agency rating is reasonable. If there are any issues that could be found by an interested observer, it’s best to deal with them upfront.

 

Finally, use an expert

Their fees will be worthwhile if it achieves the end result quickly and cleanly. (Disclosure: That’s what I do for a living). You wouldn’t build your own website, or do your own legal work – you’d employ an expert. Why should raising finance be any different? There are 30+ P2P platforms, each with a different flavour. Use someone who knows the market and can get you the best deal.

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Small Business

Leveraged Cashflow Funding – The Art of the Possible

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One of the big challenges that P2P lending faces is getting the message out to companies and their advisors that there is funding out there. This is particularly so for leveraged cashflow finance. This is also known as ‘debenture lending’, and is typically used for management buy outs or acquisitions of firms by competitors.

Leveraged Cashflow Funding comprises of a medium-term, fully amortising loan secured against the existing assets and future cashflows of a company. It is particularly suited to businesses that have strong cashflows but not necessarily a lot of tangible assets within the balance sheet.

Where it is used typically is for Management Buy-Outs or acquisitions. It can place a heavy burden on the business’s cashflow, but providing the cashflow is strong enough to begin with, then for such a specific reason and for a limited time, the risk can be acceptable. The technique can also be used for, in effect, releasing equity in a business for an owner when passing the business down to the next generation.

Where Cashflow is particularly strong, there may be no need for further security; a first Debenture will always be required, but the underlying assets may not cover the outstanding loan amounts.

If Cashflow is not quite so strong, then there may be other ways of structuring the deal, particularly when there is a strong asset base, as is typical in many manufacturing companies. As with many P2P deals, there is much flexibility in how to structure a deal.

The key number in all this will be the Debt Service Ratio. There are a number of ways of calculating this, but essentially it is the relationship between debt repayments and cash generated by the business, measured over the course of the financial year. The higher this ratio, then the better the deal, and the better the terms of any borrowing are likely to be.

There is increased confidence starting to return to the MBO and acquisition market; more companies are being bought and sold in the last few months. However, there are still many businesses and management teams sitting on their hands, because they assume funding is not available from banks. Whilst bank lending remains restricted, P2P represents an alternative means of getting the job done.

 

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P2P, Small Business, UK Banks

Throw Away the Rule Book! (Sort of….)

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One of the great things about P2P business lending is the ability to consider deal structures that are outside ‘traditional’ banking guidelines.

Bank Managers nowadays operate with very little discretion. Even where there is apparent local lending authority, a manager within the branch/commercial network will be required to operate within guidelines which effectively proscribe his or her ability to make a decision.

For example, the bank may have guidelines that stipulate no loans are to be made to bars or restaurants. There may be a restriction on agreeing overdrafts where invoice discounting lines are in place, or the rules may say that the LTV on commercial mortgages should not exceed 70%.

These are all good rules, put in place for a good reason and for many cases they will be appropriate when used as guidelines. However, business does not follow clear guidelines or paths. Life is messy. There are lots of exceptions.

This is where the flexibility of some P2P platforms is a real benefit. Although some platforms are fairly strict on credit scoring procedures, many allow businesses to make a bespoke case dependant on their own particular circumstances.

It is not true that P2P lending has no rulebook. There have to be some guidelines, and good practice in lending money will never change. However, the flexibility to judge each deal in the round opens up borrowing potential for a huge range of businesses that have had credit lines denied to them over recent years.

Looking at propositions in the round is what traditional banking used to be about; lending managers were trained to consider all the circumstances of a case – for example, a business may have little value in its Balance Sheet, or directors may have previous bankruptcies. These facts in and of themselves do not make a proposition inherently bad – proper due diligence will reveal the full circumstances, rather than there being a single killer fact.

It is therefore entirely possible to bring proposals to P2P sites that would not make it through the door of a bank; this does not mean that such proposals are inherently poor risks, simply that traditional lenders are no longer able to think creatively about how to structure a deal.

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Small Business

How Business P2P Lending Works

Business peer-to-peer lending works by putting potential borrowers directly in front of those with money. The former want cash to develop their business; the latter are looking for a good rate of return on their money.

The traditional model of business lending involved the banks taking deposits from the public and lending that cash out to businesses that needed it. The difference in interest rate between what the bank paid the depositor and what it charged the borrower was used to cover the administration of the loan and provide a profit. Both the depositor and the borrower had a contract with the bank, and each is entirely separate of the other.

The new model, used by P2P, has seen the banks taken out of the equation by technology. Potential business borrowers now approach one of the many P2P platforms who agree to list the proposal on their website. Registered members can then choose to lend money to that company if they like the look of the proposal – but note that the platform is not taking deposits, merely acting as a ‘dating agency’ between those with cash and those without. If the loan becomes fully funded, the platform takes care of the administration – collecting the cash, loan documentation, paying out the loan and collecting repayments. It typically does all this as an agent of the individual lender, rather than being the lender itself.

These differences have important consequences:

  1. Platforms do not generally guarantee lenders funds – cash is not being deposited with the platform, so the Financial Services Compensation Scheme does not apply.
  2. Proposals are vetted by the platform to a greater or lesser extent, but each individual lender must make their own decisions whether to lend to a particular proposal or not.
  3. Bad debts are personal to each individual lender, not to the platform. While the platform will have recovery procedures, there is a risk that lenders will incur losses.

There are exceptions – at least one platform has a business model where lenders are lending direct to the platform, and the platform then lends on to individual borrowers. Another platform has a ‘sinking fund’ which would, in theory, cover any loss of capital to lenders through bad debts.

The P2P market is evolving at a very rapid pace. Definitions and regulations quickly become out of date as new business models and new ideas emerge in the industry.

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Small Business

Different flavours of funding

Business Peer-to-Peer lending (P2P) is on the rise, and the sector is predicted to increase in size dramatically over the next couple of years as a wash of institutional, pension and NISA money comes into the sector. This will be good news for borrowers; maybe less so for lenders as rates will inevitably fall. We are already seeing new platforms enter the market with business models that bring lower rates to borrowers. We have also seen some established platforms change their business model as a result of the new money coming into the industry.

The range of different platforms now being established shows the P2P industry is thriving, and the range of credit appetite now available is broadening. There are currently platforms that specialise in:

  • Manufacturing businesses
  • Property
  • Property development
  • Lending against personal guarantees
  • Lending on the strength of a Debenture
  • Volume funding of trading businesses
  • Aircraft & leasing
  • Buy-to-let properties
  • Business start-ups

And that’s just the platforms which are engaged in business debt funding, rather than the personal lenders such as Zopa, and equity crowdfunders like Crowdcube. Viewed from inside the industry, it seems as though there is a new platform launching every month, even with the impact of FCA interim regulation.

For borrowers, this is good news. It means that there are many different flavours of platform, with different credit policies and different security requirements. For lenders, it means that they get portfolio diversification across a number of platforms, and a chance to invest in whatever structure is most comfortable to them.

The point here for borrowers is that as the P2P industry develops, the availability of credit increases. This can only be a good thing for UK business. However, it’s important to know which platforms will do what; there is no point a manufacturing business approaching a P2P lender that specialises in property development finance, or a director with just a Personal Guarantee to offer approaching a provider that will only consider bricks-and-mortar security.

It is therefore important to know the current funding landscape, and spend some time researching which platform is best for your proposition. Not only must you monitor new platforms emerging, but also changes in existing platforms wishing to keep their competitive advantage. For example, maximum lending amounts often go up as a platform develops, and security requirements may often relax. Throughout 2012 and much of 2013, there was also a general drift downwards of lending rates, though this seems to have halted more recnetly. Sectoral appetite may also change and platforms may develop new products and different types of lending.

Different platforms have different flavours, just as the banks used to – though the differences there are less marked than they used to be. As a borrower, approaching the right platform, with the right proposition, will save you time and effort and lead to a more successful conclusion.

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Small Business, UK Banks

Creative destruction, SMEs and the Banks

My blog today is a guest piece written by Bhanu Dhir, Vice Principal of City of Wolverhampton College.

The first time I heard about ‘gales of creative destruction’ must have been when I was 14 studying economics at school. I had visions of corporate towers being felled in apocalyptic sandstorms to be replaced by small designer studios full of clever entrepreneurs creating things we all really wanted. At that time I did not really know who Joseph Schumpeter was and I did not fully understand that his view on capitalism was that innovations by entrepreneurs are the force that sustains long-term economic growth, even as it destroys the value of established companies. 

 
Reading through Prophet of Innovation – Joseph Schumpeter and Creative Destruction by Thomas K. McCraw I am warmed by the idea that innovators can challenge the monolithic ‘old guard’ through credit based entrepreneurism thereby ensuring that as a consumer I am always going to be offered fresh alternatives. The ‘gales of creative destruction’ will sweep away all those inefficient and staid oligarchs and if any of the new innovators aspired to become boring and stuffy they too would be destroyed by the same process that enabled them to become established in the first place. Perhaps a romantic view but credit fuelled innovation where the providers of finance and entrepreneurs worked hand in hand to manage the risks associated with a portfolio of opportunities seems very sensible to me.
 
Of course the Schumpetarian view of capitalism depends on the ready availability of capital and the management of risk. Risk free business cannot and should not exist within a capitalist superstructure. It is a nonsensical notion: but if a bank is not prepared to provide credit to an innovator without the guarantee of success, aren’t we faced with rationalising absurdity? 
 
The media is full of conversations about the funding gap for SME: apparently it is between £84bn and £190bn. This means innovators out there with business ideas collectively worth colossal sums of money are being denied the opportunity to create wealth (ok, I accept that some of the business ideas might not even be worth looking at). Schumpeter must be turning in his grave. Who benefits from this refusal to fund creativity? It is not the entrepreneurs. It is not the consumer eager for innovation and value for money. I can understand banks wanting to reduce risk – after all, their shareholders will be unhappy about losing their investment. But who are the shareholders? People like you and me, innovators or private equity companies who want risk free return on investment and a way to snuff out any wind at all let alone ‘gales if creative destruction.’
 
Banks may well refuse to lend money to small businesses (but pretend to be doing just fine in meeting government targets). That is fine; let them live in their own risk free world where they will stop free banking, hike up fees and get their risk free income as a consequence of the passivity of consumers. I have heard said that the UK is 15 years behind the US in terms of its finance market. Non bank lending to SME is common in the US. Crowd funding, peer to peer lending and exchange are commonplace. I say take your money out of your bank, set up or join a credit union, find new ways to support local entrepreneurs, manage risk and create a hurricane for our banking industry.
 
I am going to see if I can get someone to fund my ‘Go Schumpeter Go’ t-shirt business.
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Cashflow, Small Business, UK Banks

Debenture Lending, or ‘Why can’t I get an overdraft?’

Debenture lending used to be the main way that SMEs, particularly manufacturers, were funded by their banks. It involved lending on overdraft against the value of the company’s debtors and stock. As a young managers’ clerk, I used to have to do regular ‘break up ’assessments to value what debtors, stock, WIP and raw materials might be worth in a forced sale situation. Every month customers would send us management accounts and it would be down to the managers clerk to check that lending was within guidelines – a fairly typical formula being that balance sheet asset value had to be two or three times the overdraft limit.

Back in the day, this was a popular and relatively easy way of lending to companies to fund their working capital cycle.

Things started to change in the mid-90’s as invoice finance became more accepted. It’s generally accepted that the USA is around 15-20 years ahead of the UK in terms of funding, and invoice finance came to the UK with a long established track record. However, poor implementation and some horror stories meant that it began with a tarnished image that has only really improved (of necessity) in the last few years. Even now, some contracts issued by large companies or local authorities to their suppliers still specify that debts cannot be assigned to a factoring company.

The two main factors underpinning greater use of invoice finance by SMEs were changes in company case law that meant the banks could not place as much reliance on company assets as security, and a realisation by the banks that invoice finance lending was simultaneously far less risky and wildly more profitable than traditional Debenture Lending. Banks (who all have their own invoice finance arm) also believe that they have more control over both the lending and the underlying assets if an invoice finance solution is used instead of an overdraft, which they view as essentially a big pot of money at the disposal and control of the company.

Nowadays, it is rare to find lenders who will fund companies’ working capital cycle by overdraft. There is a general presumption in favour of invoice finance. However, many bank managers who have cut their teeth under the new normal do not realise that for many clients, there is a portion of the debtor book that cannot be financed, either because it is to connected companies, or there is too much concentration on a single debtor, or credit limits can’t be set at a high enough level. This leaves a portion of sales, and hence working capital, unfunded. The standard, uncritical, bank answer to an overdraft application is ‘you need to factor it instead’.

And this also leaves aside those industries in which invoice finance has a hard time operating, like construction where the debt is contractual and hence not secure until contracts are fully completed. Other industries where invoice finance does not generally work well is service firms and professional firms, though some of the more innovative invoice finance companies have had a go at some of these areas.

The approach that banks take nowadays is to either refuse an overdraft request and direct companies towards an invoice finance solution, or to simply lend against the value of bricks and mortar e.g. directors houses or the business premises. The days of banks taking account of the value of assets within the balance sheet of a company and lending against them have largely passed.

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