Alternative finance is the hot new thing. And as is always the case with hot new things, investors are desperately looking for the new, new thing – the next big disrupter. But I’d ignore all the talk of marrying cryptocurrencies to peer-to-peer banking systems. I’d look instead at three simple concepts: lending to students; lending working capital to businesses; and the rise of secondary markets for private equity.
So far, the standout success story in the student loans area is US-based SoFi, but I expect localised versions to take off here. More than $3bn has now been loaned via SoFi’s platform due to one key insight: traditional credit-scoring systems aren’t up to the job. Put simply, they rate you based on your past behaviour. So lenders prefer to lend to those who have borrowed in the past, and repaid the loan, proving themselves reliable. If you haven’t borrowed before, you pose an unquantifiable risk, and so may not be deemed suitable. Clearly, this can be a problem for students and recent graduates.
Yet some students represent a great bet. They might attend high-quality universities, doing degrees that will land them on Wall Street or in Silicon Valley. These are low-risk candidates with huge earnings potential, but traditional credit-scoring misses them. SoFi doesn’t.
It lends aggressively to what it thinks are sensible borrowers. It’s growing so rapidly that, in a scramble to meet demand from institutions, it has pioneered new structures, such as securitisation (where lots of individual loans are bundled into one security, then lent on to big banks and hedge funds).
Also promising are platforms that meet demand for working-capital funding. Private investors can use a peer-to-peer loan platform such as FundingCircle to lend to small businesses for up to five years, with rates of return from 6% to 18% a year (before costs and defaults). But many businesses don’t want to borrow for that long. They might only need the money for a few months to a year.
This gap represents a big hole in the balance sheets of Britain’s small firms. Banks traditionally filled this hole with overdrafts, but the fees can be expensive and banks often demand personal guarantees from the business owner. As a result, many firms now turn to alternative lenders (big names include MarketInvoice and Platform Black, but there are many more) to meet their needs. The exact business models vary, but they all enable short-term borrowing – from a few months to a year.
Iwoca is one such platform. It typically offers loans at rates of 14% for six months. It’s quick, flexible and well suited to businesses that want to borrow less than £50,000. The platform manages risk by analysing cash flow, accounts and balance sheets.
Another relatively new platform, ArchOver, has a slightly different model. Loans for up to a year are secured against the invoices receivable account – cash coming into the business – so that directors do not have to offer personal guarantees. ArchOver prefers to lend larger sums – more than £100,000 is typical, with sums up to £1m in the works – and the interest rates are much lower than Iwoca’s. ArchOver also insures any risk via a Lloyd’s of London broker, making this a relatively lower-risk proposition for the bigger investors on its platform.
ArchOver and Iwoca are just the tip of this sub-sector (if you are in business and want to explore funding options, I’m running a special workshop on the sector in London on 20 July. For investors, the opportunities could be huge, but remember you are lending to firms that need cash quickly, which clearly carries risks.
Finally, why buy shares in young, crowdfunded businesses from the likes of Crowdcube and Seedrs, when you can buy into more established private businesses via a “secondary market”, run by the likes of Asset Match?
Asset Match and its rivals are effectively stockmarkets for unlisted businesses, many of which have already been funded by private-equity groups. These markets allow investors to trade positions to other insiders via an auction, and Asset Match is expanding fast into other areas – for example, if you want to buy into ArchOver’s loans after they’ve been issued, Asset Match now offers an electronic marketplace.
This idea of using a private market rather than London Stock Exchange’s Aim, for example, will grow over time and we’ll see real opportunities to invest in more established businesses. We might even see a whole generation of crowdfunded and venture-capital-backed businesses offer shares in later funding rounds via these platforms.
Risky? Certainly, especially given the relative lack of disclosure to outside investors. But I’d argue not much more risky than some of the crackpot penny stocks listed on our over-regulated London markets or in the US via the “pink sheet” over-the-counter markets.