Financial innovation is unlocking additional funding for small businesses that have been declined by their bank. Katrin Herrling, co-founder and CEO of Funding Xchange, explores.
The reluctance of banks to lend to businesses in the wake of the financial crisis kickstarted massive innovation in business finance. In particular, peer-to-peer (P2P) lending is often seen as the poster child of innovation in the finance sector, with Zopa, Funding Circle and RateSetter being some of the largest and most well-known P2P lenders.
P2P puts the spotlight on how these lenders source their own funding (from “peers”). That was helpful during the banking crisis when funding was scarce and today, P2P lenders have been disruptive largely because they have made it convenient to apply for funding (online, at any time) and provide customers with decisions on their lending application in hours or days. Credit goes to these lenders for transforming the customer experience.
Yet, focusing only on P2P misses a huge part of the story of how funding in Britain is changing. Slick processes are not necessarily unlocking additional finance if the lenders are just replicating underwriting models of the past, building up large underwriting departments and looking for similar risk profiles as banks.
A better understanding of risk is unlocking funding
To unlock additional funding, innovation has to focus on finding better ways to assess business risk, for example by gaining access to more timely and accurate transaction data, seizing “big data” insights, or leveraging the rise of cloud accounting to see “live” business performance. At the same time, it is important to find ways to reduce the operational costs of underwriting and to insure risk or secure funding against future income streams. These innovations are making it possible for a much broader range of businesses to be funded on terms that are attractive.
We estimate that there are at least 100 finance providers in the UK that have launched innovative solutions in the past six years. Some of them successful start-ups like Urica. This funder has access to trade credit profiles of 40 million companies anywhere in the world and uses this data to unlock funding for companies that export internationally. This turned out to be a great solution for a client who had been declined by a bank as their success in exporting to China was seen as ‘concentration of risk’ by their bank.
Some P2P lenders have also led innovation in developing new products. For example, MarketInvoice has brought single invoice finance to small companies who can use outstanding invoices almost like an overdraft or revolving credit facility. This made it a great solution for a fast-growing artisan food company that had just delivered its first large order to a national supermarket chain and needed working capital to produce the next order. They could not wait for 90 days for the payment of the first order and turned to MarketInvoice to release the funding in a few days.
But it is not just newcomers who are innovating. Macquarie, a large international bank, has just launched an innovative asset finance solution that offers quick decisions and considers “soft assets” as collateral. Traditionally, it is difficult to use soft assets to secure finance as the recovery value is limited. Macquarie is assessing how important the asset is to the functioning of the business – and will make funding available for “business critical” assets. This made it possible for a real estate agent to take out finance for a new telco system at highly competitive rates.
But innovation is baffling borrowers
However, the specialisation that is the result of innovation in underwriting models is baffling to borrowers. It is hard for any one business to find the right funder and the best terms for their specific situation. Businesses are typically not aware of the funding options that might best meet their needs. Too many businesses are ending up getting rejected again as their profile does not fit with the lender they approached. It is probably not surprising that reject rates of alternative funders are significantly higher than banks’.
The government has recognised that businesses need help to be connected to those finance providers who want to fund them. This is what the Bank Referral Scheme, launched on 1st November 2016, is seeking to achieve. Three finance platforms – including Funding Xchange – are now filling the gap by mediating between businesses and finance providers. For us the mission is to simplify access to business finance and deliver the best available quotes from the whole of the market in a transparent and unbiased way. We believe, this is the way to get credit flowing to businesses again.