Alternative finance: Not on the high street

Peer-to-peer lending is one of the fastest emerging forms of alternative finance – and construction companies frustrated by banks’ attitudes are starting to make use of it. Will Mann explains.

Despite three years of almost uninterrupted growth, the construction industry still faces a major problem: banks don’t want to touch it. “We’ve had numerous instances of members telling us banks have turned down overdrafts or loan applications, even when they have a solid credit rating,” says Paul Bogle, head of policy at the National Federation of Builders (NFB). “The trouble is, construction companies simply don’t fit with the banks’ risk profile. But it’s still possible to get debt finance from an alternative lender at the same – or even a better – rate than the banks,” he continues.

As Bogle says, the high street banks are still cautious on SME lending, with reduced lending rates probably stemming from their historic debt, low capital base or even, in some cases, skills shortages in specialist lending teams. But construction SMEs facing a lack of finance, or wanting better terms, do now have other options for securing debt finance: they’re seeking funds just as “disruption” in the lending industry has brought  the rise of “alternative finance”.

These are lending channels that have emerged outside the banking system, including crowdfunding, peer-to-peer lending,and invoice trading platforms. 

According to Bogle, the NFB is currently encouraging its members to investigate these growing alternatives to high street banks. The largest sector in alternative finance, and the fastest growing, is peer-to-peer lending (also known by the acronym P2PL), also known as social lending and crowdlending. Virtually unheard of in business circles just five years ago, by 2013 the sector had lent £550m, rising to a total of £5bn in 2015, with lending to businesses currently running at almost £2bn a year.

Peer-to-peer lending differs from other forms of alternative finance, such as crowdfunding, in that it provides debt finance, rather than equity in the style of the BBC’s Dragons’ Den series. Funds can be used for working capital, bridging finance or perhaps a commercial mortgage or a development project. (For more on how it works, see Q&A below).

The first peer-to-peer intermediary company, Zopa, was established in 2005, specialising in providing personal loans. The first to provide business loans was Funding Circle, set up in 2010, which is now the UK’s second biggest lender overall and the biggest to companies. Its investors include the government-backed British Business Bank, 19 local authorities, a university and a range of financial institutions.

Other peer-to-peer “intermediaries” include RateSetter, Rebuildingsociety, CrowdProperty, ThinCats, Assetz Capital, FundingKnight, LendInvest, LandBay, MarketInvoice, Wellesley and Lending Works. The trade body for these is the Peer-to-Peer Finance Association, and the sector is regulated by the Financial Conduct Authority.

While the sector originally acted as an intermediary between borrowers and private retail investors, in the last few years the banks and other financial institutions, such as hedge funds, pension funds and insurance companies, have used them as a lending channel – taking higher risks for higher returns. “In the next 10 years, alternative finance could account for 40% of commercial finance by banks,” property finance specialist Parik Chandra of Funding Circle told a recent NFB conference. 

Since launching, Funding Circle has loaned just over £1bn in total to businesses, and provided 2,488 loans worth £263m to the construction and property market, proving a lifeline for several construction companies frustrated by the banks’ attitudes (see case studies below).

“Some 30% of businesses who come to us wouldn’t have got funding otherwise,” says David de Koning, Funding Circle’s head of communications. “But we are not a lender of last resort. In fact, companies who use us find the experience better than using banks. Businesses want speed and certainty, and the whole loan application process gets funds into your account in typically just two weeks.”

De Koning says that the companies that come to Funding Circle represent a broad cross-section of industries and sectors  across the UK. That said, one sector that does seem particularly well suited is property development, where the buoyant market, particularly in London, offers high returns. The highest P2PL loan approved to date was £4.1m for a residential housing project in Croydon, by LendInvest, on a 12% annualised rate of interest.

Funding Circle has a ceiling of £1m for unsecured loans, but has recently upped that to £3m for loans secured on property. The venture arranged loans worth a total of £115m to property borrowers last year, according to Chandra.

The future for alternative finance, and for P2PL in particular, looks rosy. An independent report by Nesta Investments and the University of Cambridge in 2014 forecast that the UK alternative finance market would be worth £4.4bn by the end of 2015, of which business P2PL would account for 43%. In 2012, its value was just £267m.

The government has welcomed this upstart challenger to the traditional financial system, with junior Treasury minister Harriett Baldwin calling P2PL “a brilliantly innovative new form of finance – which we want to see continue to grow and evolve”.

Additionally, following a 2014 consultation, the government has introduced new regulations that will force banks to refer SMEs rejected for loan applications to the alternative finance market, including providing names of intermediaries. For instance, RBS is now directing would-be business borrowers that fail to meet its lending criteria to P2P lenders Funding Circle and Assetz Capital. 

The NFB’s Bogle welcomes this development and believes alternative finance and commercial peer-to-peer lending will only grow. “As more companies take out these loans, there will be an increased level of comfort and confidence,” he predicts. “We will also see banks looking at offering alternative finance themselves, as a defensive move, because they want to retain control of the lending market.”

Bogle adds that “2016 is a key year” for construction companies to look at alternative finance. “As an industry, we are wrestling with increased costs, but there is a healthy pipeline of work – so it’s vital that businesses look at all finance options open to them,” he says.

How much, how expensive and how risky?

The key questions about peer-to-peer lending answered.

What is peer-to-peer lending?
Intermediary or marketplace websites match individuals or companies who need finance with savers or investors looking for a good return on their money. The process, also known as crowdlending or social lending, bypasses traditional financial institutions such as banks, so borrowers can sometimes get slightly better rates, or find credit when they have been refused elsewhere.

How do you apply for a loan?
Loan applications are made through a questionnaire on P2PL intermediary websites. This is then assessed by the intermediary. Start-ups are not usually considered; Funding Circle filters out any company less than two years old and with turnover below £50,000.

Applicants with a poor credit history, for example a county court judgement, are also unlikely to be approved. If successful, the intermediary will usually assign the company a risk rating – from A+ to E – which is used to determine the interest rate. It will then post details of the application on its website and market the requirements to potential lenders.

How quickly will I find lenders?
There’s no set length of time – it all depends on who’s looking for a loan at a particular time and at what rate. But the speed of loan turnaround is generally good compared to banks. Most lenders say two weeks is the norm.

What are the interest rates?
Interest rates are set in one of two ways: by lenders, who compete for the opportunity on a reverse auction model; or by the P2PL intermediary based on the borrower’s risk rating. Funding Circle has recently switched from the former to the latter, saying that “investors prefer the certainty”. Its rates range from 6% for A+ rated companies to 18.1% for E rated firms.

How long are the repayment terms?
They can range from six months up to five years. There is no penalty for early repayment.

How much can I borrow?
There is no minimum loan amount, though most lending to businesses is for sums in the tens of thousands and upwards. The highest P2PL business loan approved to date is £4.1m.

Are there any other costs?
Lending intermediaries charge a one-time fee on funded loans from borrowers and a loan servicing fee to investors, normally a fixed amount annually or a percentage of the loan amount.

What are the risks?
For borrowers, the principal risk is generating sufficient revenue to pay back the loan within the agreed term on what may be a high rate of interest. Funding Circle says it works with companies that struggle with repayments or default, and may reschedule the loan. It adds that its bad debt level is around 2%, which it says is comparable to the high street banks.

Case study K&M Interior Solutions

K&M Interior Solutions is a drylining contractor, based in Watford, Hertfordshire, which specialises in high-end residential projects in London.

The company was set up in 2012, and quickly built its reputation, with work enquiries flowing through the door. Managing director Kim Krogdahl (pictured) decided to expand the business, but faced one problem: cashflow.

“We were being offered more work, but the upfront cost for labour and materials was going to be massive, and we were still waiting for retentions on our completed contracts to be paid,” he says.

So Krogdahl began exploring debt finance avenues. He ruled out going to his existing high street bank because of their antipathy towards construction, while another lender said that his growth plan was “unrealistic”. But he got a more positive response after speaking to peer-to-peer lender RateSetter in 2014.

“We had to provide a comprehensive business plan, with full accounts and forecasts, but the customer experience was much better than dealing with a bank,” Krogdahl says. “It was also much quicker – the loan was approved in two weeks.”

The RateSetter loan gave K&M the cash reserves to start new contracts while it was waiting for the retentions to come in.

“Undoubtedly, that loan is the reason we’ve been able to grow as we have,” says Krogdahl.

“We posted revenue of £146,000 in our first year, £1.1m in the second, and we’re now up to about £2.4m. We are still growing and the plan is to get to £4.5m. And if we need any more debt finance, we’ll be going back to RateSetter.”

Case study: GRA Project Management

GRA Project Management is a Norfolk-based civil engineering contractor that specialises in drainage, with a turnover of around £2.5m and contracts from £35,000 to more than £2.5m. Its clients include Balfour Beatty and RG Carter.

Managing director Gavin Armstrong (pictured) turned to peer-to-peer lending three years ago after becoming frustrated with banks. “They are very wary of construction nowadays,” he says. “We tried to get a £100,000 overdraft and were turned down, whereas pre-recession it wasn’t a problem to get £200,000.”

GRA wanted finance to purchase machinery – excavators and dumpers – plus some working capital for a civils project for Balfour Beatty. “With 60-day payment terms, and 20 to 30 guys on the job, there are major upfront costs before you can start a contract,” says Armstrong.

His business has taken out three peer-to-peer loans through Rebuildingsociety: £50,000, £100,000 and, most recently, £315,000. “The process is quite straightforward – you answer a series of questions, and Rebuildingsociety do a fairly rigorous background check before they allow you to bid. Depending on the amount, you have to put down a personal guarantee, and for the third loan I also had to arrange a second mortgage on my family home,” says Armstrong.

“The rates are higher than what you would get from a standard lender – 14% – but that’s the price you have to pay. It gets me working and gets me a return,”
he says. “If I need it again, I know where to go because the lenders now have confidence in my business. One individual lender provided £100,000 of the last loan because I repaid the previous two quickly.

“I will pay off the latest loan in a month’s time – only 18 months after taking it out – which will be two years ahead of schedule. Peer-to-peer finance has been fantastic for our business.”