Risk & Economy » Regulation » Claiming the pot of gold

THE HIGH-PROFILE entry by Wonga, the controversial payday lender, into the business loans market has thrown a spotlight on the problems companies face in obtaining funding.

Five years after the onset of the financial crisis first caused liquidity to freeze, availability of finance is still extremely tight, while the cost of loans can vary greatly.

The latest survey by the Federation of Small Businesses found that almost half of the companies that applied for credit were rejected.

A quarter of the 3,125 businesses surveyed applied for funding in the first quarter of the year, with almost half (44.5%) successful while nearly as many (40.6%) were not, as the balance of bids remained pending.

Almost half of the businesses that successfully applied for loans were offered an interest rate below 5%, the rest had to pay at least 5%, with one in six paying more than 11%.

According to Christopher Shaw, chief executive of Platform Black, an invoice trading company that enables SMEs to raise finance by selling their unpaid invoices to buyers online, the bank loan situation is dire.

“If they can get funding, it’s on terms that are quite onerous. They are having to pay a lot of money in arrangement fees and high interest rates, and having to give personal guarantees, business debentures or even giving up equity in the business,” he explains.

Figures released by the Bank of England in April compounded the grim picture faced by Britain’s credit-starved companies. According to the BoE’s Trends in Lending report, businesses experienced a £4bn lending squeeze in February as companies were found to be paying back more than the banks were handing out in the form of new loans.

The drop was the worst experienced in nearly two years, while the government’s much-vaunted Project Merlin, by which the four biggest UK banks as well as Spanish group Santander were to make more cash available to SMEs, fell short of expectations. However, the Bank’s figures showed the banks exceeded their gross lending target of £190bn by £24.9bn.

In February, the BoE released figures that showed a £9.6bn contraction in business lending in 2011, while lending to SMEs under Project Merlin, at £74.9bn, fell £1.1bn short of the target. The prospects for the year are not that promising either. According to Ernst & Young’s Item Club economic forecasting group, UK bank lending is likely to shrink this year for the first time since 2009, with corporate loans expected to decline 5.7%.

Commenting at the time that the Merlin lending statistics were released, Lee Hopley, chief economist at EEF, the manufacturers’ organisation, said: “While meeting or coming close to the lending targets agreed in Project Merlin demonstrates banks are true to their word and are showing some intent to lend, the reality is that SMEs continue to be frustrated by the cost and terms and conditions around lending, with some opting out of using external finance altogether. This cannot be good for growth.”

Failure of tradition
According to Russell Gould, head of Wonga for business, it was that failure of the traditional funding providers that prompted his company to make its move into the arena.

“We recognised that in the current environment banks are withdrawing overdraft facilities left, right and centre, making it hard for viable businesses to get the funds they needed,” he explains.

Wonga’s business loan process takes 15 minutes as it is, based on what Gould calls a “fantastic algorithm” that uses publicly available data on the directors and the business itself.

However, for many applicants, the big issue will be the price, especially in the wake of reports that its consumer loans come with an annual percentage rate (APR) of 4,214%.

For businesses, Wonga charges between 0.3% and 2% a week for loans of up to £10,000. They must also pay an arrangement fee of 1-5%.

Wonga says that, on an annual effective rate (AER) basis, the 0.2% weekly fee is equivalent to 17% AER while the 2% rate comes out at nearly 112%.

This means a business borrowing £10,000 for a year at the top rate and paying a 5% fee would pay total costs of almost £11,000.

However, Gould insists Wonga’s service is aimed at short-term finance that would normally be met by an overdraft.

The final rate the borrower will pay – which is agreed up front – will depend on the length of the loan and, more importantly, on how Wonga’s algorithm assesses the company. “It depends on the business itself,” says Gould.

“Businesses at the better end of the small business arena will get the lower end of the rate and, for them, it will be very competitive. Our product provides an alternative [to overdrafts] for those emergency situations where businesses need short-term finance for three or four weeks to cover a late invoice or to buy additional stock.”

Modern technology
While Platform Black also uses online technology – the company offers a modernised version of invoice discounting – Shaw is not convinced that Wonga is the right solution.

“I don’t think a payday-type loan, which is what Wonga is offering, is a viable way to fund a well-run business,” he says.

“A business should be looking to a more planned and constructive approach, whether that’s our model of invoice financing or long-term loans with reasonable interest rates.”

Gould dismisses this claim, saying Wonga is more competitive than other sources of finance, such as invoice discounting which he describes as “complex” and “quite restrictive” in terms of the services offered.

Asked about what his clients have paid, Shaw claims it is too early to provide a definite answer, as Platform Black only launched a marketing campaign in April.

So far, sellers are getting somewhere between 98.5 and 99.5p in the pound on their invoices, which is equivalent to 0.5- 1.5% – generally an APR of somewhere between 7-16%.

“People are registering with us because they want this tool in their toolbox, and to be ready to use it on those occasions when they have a new project, need to hire new staff, or are just going through a pinch point,” he says.

Peter Ewen, managing director of ABN Amro Commercial Finance – a company that has offered asset-based lending and invoice finance for 23 years – is also sceptical of Wonga.

“It will possibly fulfil a need but certainly the costs with which they are involved cannot be very good for businesses,” he explains. “If businesses have to access finance at those sorts of rates, there must be better alternatives.”

In the future, Gould claims, alternative finance – based on better use of technology – will increasingly replace traditional bank funding.

“Small businesses are demanding much more on flexibility and transparency and they are not getting it from traditional providers,” he says.

Shaw agrees with this statement, claiming business finance is entering a “new normal” – and adds there is little prospect of a return to a traditional bank model.

“I don’t think the banks will find it profitable enough to go back to doing business with SMEs at a level those SMEs are able to afford,” he concludes.


Alternative finance is beginning to gain a toehold. According to a survey by Bibby Financial Services, some 14% of businesses that were offered credit in the quarter to March used invoice- and asset-based lending.

A third (32%) resorted to personal savings and 20% to a credit card. However, 91% took an overdraft or loan, as well as other sources, showing bank finance is still vital.

Ewen claims the reform of bank regulations means there will be a “structural change” in business financing that creates an opportunity for alternative finance.

“This does mean that alternative sources will be picking up the baton where banks are having to reduce the size of their balance sheets,” he says.

The industry, government and business advisors need to ensure companies understand the alternatives which will be key as banks retreat, he adds.

“If people open their eyes, they will see how the industry has changed and that it is no longer the lender of last resort,” he explains.

“Our products are a lot more sophisticated and there is a huge opportunity but customers need to be open to it.”

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