3 years into the banking crisis, and still the newspapers carry headlines like this one in a recent edition of The Telegraph indicating that - whatever the veracity of lending statistics - it is abundantly clear that relations between banks and business remain less than cordial and will presumably remain so for some time to come.
One potential White Knight riding onto the non-bank funding scene comes in the shape of 'Crowd Funding' where wealthy individuals can get a return on their money by lending it at commercial rates to businesses or private individuals. The lending might take the form of term loans (typically 1 - 3 years) or equity funding.
On loan facilities the investors effectively bid for each proposal thereby setting the sell rate based on its popularity, whereas equity investors are liable for their own due diligence and will reap rewards based on the performance of their specific investment, just as if they had invested on traditional stocks and shares.
I have been watching Crowd Funding closely for almost a year, really to see whether it took root or whether it was just 'another Internet concept'. Pleasingly it seems that some strong players have emerged and that peer-to-peer loans are rapidly becoming acknowledged as a credible alternative to traditional bank lending.
Moreover, some of the founder organisations have come together to create a code of conduct designed to keep rogues out of the market. Of course there will always be the fear that this will restrict competition, a scenario which should be avoided but applied wisely, should avoid borrowers falling victim to less scrupulous operators who always circle the money business.
The symbiotic relationship between banks and their business customers was simultaneously their greatest strength and their greatest weakness; it was very easy for a customer requiring finance. From a glance at a screen the bank could get a thumbnail of turnover, trends and a snapshot of financial health and make a swift judgment. On the downside, if things started to go wrong this could swiftly knock on to all business and possibly personal finance arrangements in many cases leaving the customer with nowhere to turn. The ease with which these arrangements could be made or terminated resulted in the cliche of banks handing out umbrellas in the sunshine only to take them back when it started to rain. With an external lender they have no up-front knowledge so are reliant on the customer supplying good quality, current information - something which was often overlooked in the hedonistic pre-crash era.
By using an external loan provider, banking lines will be left untouched and as long as payments are maintained there will be no interference with trading or security position. It is early days but common sense suggests that it is more economically intelligent to nurse default cases than to tear in with guns blazing.
Overall, I can see Crowd Funding, or Peer-to-Peer lending as a viable and sustainable business tool - it really is banking without the bank; the lender gets a rate of return well in excess of bank deposit rates, and the borrower gets a commercially sensible borrowing rate - truly a win-win situation! So, what are the pitfalls?
I have touched on issues of integrity, which could range from marginal operators who might be under-capitalised to out and out villains, though the industry is typically good at weeding these out.
More concerning is the issue of bad debt - particularly in equity models - extensive due diligence is not financially viable and simple statistics indicate that as many as two thirds of investments will not generate sufficient return to cover investment - whist as many as a third might completely fail. This is clearly an inherent risk of share investment, but if investors complain en-mass they might stir the FSA into paying special attention to the sector and potentially strangling it with regulation. The effects will be less with loan products, but it is not yet clear if investors are really fully aware of its impact, or whether they will simply turn away from the scheme when returns are hit by debts.
Overall, my though is that the sector is doing a pretty good job of regulating itself and is worth researching further if you are looking for business loans or capital or, indeed if you have a spare few bob for a mid-risk investment.
If you want to know more about Crowd Funding, or conventional business finance, call me on 07932 075754
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