ONE CRY heard across the Financial Director sphere is that of the difficulty, and cost, with which finance is accessed. And so, as it becomes increasingly troublesome for those of an entrepreneurial disposition to gain the necessary capital to grow – or, indeed, set up – through traditional methods, alternatives have begun to appear.
Many look for a benefactor or attempt to fund their venture themselves, but in recent years a new model has emerged: crowd funding and peer-to-peer lending. And there is ample opportunity for such activity. A report by Legal & General CEO Tim Breedon estimated that, between 2012 and 2016, demand for business finance could exceed supply by between £84bn and £191bn, of which between £29bn and £59bn is related to SMEs.
At its heart, crowd funding is relatively straightforward, with capital collected from multiple backers to fund an initiative. In some cases, backers are rewarded for their commitment with incentives of varying forms. Peer-to-peer lending works in much the same fashion, but uses loans instead of simply supplying capital. Investors can expect interest rates of as much as 6%, dwarfing the banks’ best of 4%.
In particular, the arts have found the method effective in enabling projects that may otherwise have fallen by the wayside and, most appealingly, in being free from the influence of studios and other corporate constraints. Kickstarter is perhaps the most prominent in the area. Since its launch in 2009, 6.3 million people have pledged more than $1bn (£590m), funding 62,000 projects.
Perhaps most notably, rock star and former Dresden Dolls front-woman Amanda Palmer raised $1.2m on Kickstarter from 24,883 fans for her album The Theatre is Evil in 2012. To this day, Palmer’s effort represents the one of most successful crowd-funding capital-raising drives.
Certainly, the model has been incredibly useful for creatives and one-off projects, but its use for wider business is somewhat more nascent.
“It’s important that businesses become more aware of it,” the Federation of Small Businesses’ policy chairman Mike Cherry tells Financial Director. “The government support it has received has been important in its development and as it develops, it will less be seen as alternative finance and more mainstream. Banks will no longer always be the first port of call.”
Unlike Kickstarter and its ilk, which exist primarily for the arts, providers such as Funding Circle have stepped in to the market in order to fund wider entrepreneurialism. In total, Funding Circle has supplied about £280m of loans and equity from nearly 30,000 investors since its inception in 2010.
“The peer-to-peer side is more grown-up in the way it presents itself,” says online media entrepreneur and lecturer Christopher Bingham. “Funding Circle and Angel operate slightly differently. Kickstarter and most of the public-facing ones have strict policy against giving equity or interest and returns on their investment. It’s purely a purchase of a product.”
However, there is “an undeniable PR value” to using Kickstarter and its luminaries, Bingham explains.
“It’s a trusted system which people understand and there’s marketing behind them on top of whatever marketing you bring to the table. The ‘ticking clock’ element is really useful and the perceived connection with the creator is what drives sales on Kickstarter, rather than purely wanting the product,” he says.
One of the biggest selling points for businesses in using the method instead of traditional bank-based finance is the relative immediacy of the access to cash. Not only that, but peer-to-peer loans are not secured against assets.
The typical borrower from Funding Circle requires a loan of about £60,000 and has a turnover of between £500,000 and £1.2m.
“At that end of the market, it’s hard for banks to lend profitably,” explains Andy Davis, author of the Centre for the Study of Financial Innovation’s report Seeds of Change: Emerging sources of non-bank funding for Britain’s SMEs. “It’s labour-intensive for them and few of these businesses have assets for them to lend against.”
For the new lenders, however, there is a new problem: that of access to sufficient, quality information about their borrowers and their financial position.
In carrying out SME credit assessments, access to the business’s current account records provides a “crucial insight” into its cash flow – and into its ability to service any loans. Normally, that information is available only to the company’s main bank, which puts any other organisation that wishes to lend to that company at a significant disadvantage.
However, data-mining initiatives such as Future Route, CreditPal and Funding Options have gone some way to act as a salve for that problem, Davis found. And while there’s no central, publicly available database of funding sources for SMEs unsure of their options, there are several initiatives aimed at providing business owners with a more comprehensive view of the market, improving the visibility of alternatives.
As such, Davis expects crowd funding and peer-to-peer lending to grow in the space where banks typically see less benefit. And indeed, the crowd-funding space has in recent years become, well, crowded with increasingly niche providers.
Kickstarter, IndieGoGo, Sponsume, GoFundMe, Rockethub, PeopleFund.it, Unbound, Gambitious, Spot.us, GigFunder, Angel.co, Smallknot, Kiva, Patreon and Subbable are all part of the plethora of narrowly targeted providers that have begun to make up the crowd.
“Naturally, these niches populate and it comes down to how much the market can take,” Davis notes. “It’s to do with liquidity. First, you get the proliferation, then a consolidation, and some will fail as the market settles down.”
Bingham concurs, but expects the market to continue its expansion for the time being, particularly given the weakness of the traditional financial powers in the entertainment industries.
“I don’t think we’ve reached the peak of the amount of money that can flow through the entertainment side of things,” he says. “We have yet to hit a ceiling for the amount of money audiences are willing to pour into films, TV shows, web series and games. I think the amount of people wanting to use crowd funding for those things will increase because of the flux that’s occurring in their existing business models.”
For wider business, though, there is more stability and, as such, that side of the market is less volatile.
“There is an element of it that is similar to the way the entertainment market has developed, with new names appearing frequently, but the market is definitely maturing,” explains Funding Circle’s David de Koning.
“We are starting to see some larger lenders get some cut-through and become more established. Within the next decade, the sector will become more mainstream and competitive with banks. In the short term, you’re unlikely to see Funding Circle or any others lending to John Lewis, but of the £7bn total lending each month, it is estimated about £1.5bn is peer-to-peer.”
That assessment is certainly borne out in the FCA’s appointment as the sector’s regulator in April, which adds further legitimacy to the movement. Strict checks and balances have to be in place as a result, ensuring investment is ring-fenced from companies’ finances. Firms must also have a third party in place, ready to take over if the worst should happen and the platform goes under. Regulation also sees a statutory 14-day cooling-off period following an investment in case of a change of heart, while disclosure becomes paramount.
“The key thing to bear in mind is that crowd funding is now another in the range of viable options for business,” Davis says. “Banks remain deeply unpopular in Britain, so it is not surprising that a common theme among the new players is to appeal to savers and customers on the basis of social value and transparency – as well as financial return. The new crop of entrepreneurs are positioning themselves to answer a public desire for social utility as well as profit.” ?
CASE STUDY: Burrito bonds
Mexican restaurant chain Chilango has spiced up the mini-bond market with the launch of its Burrito Bond, which aims to raise £1m to fund further expansion of the restaurant chain across London using a new mini-bond service from Crowdcube, an equity crowd-funding platform.
The new product, which effectively works in the same way as a retail bond, will enable Chilango to access finance from a crowd of registered investors, as well as their own customer base and the general public.
The Burrito Bond aims to raise £1m to accelerate the planned opening of three more restaurants in London this year. Investors will get 8% interest per annum over the four-year term of the bond.
Chilango’s co-founder Eric Partaker is enthusiastic about the offer: “Our Burrito Bond is the perfect way for us to engage with our loyal following as well as Crowdcube’s investor base and accelerate our expansion plans with additional growth capital.”
Crowdcube’s 73,000 registered members provide a ready-made investor audience in addition to the issuers’ own customer bases and the general public. Investors in bonds receive a regular, fixed rate of cash interest. Bondholders may also receive additional benefits (dependent on the issuer), such as discount vouchers, access to loyalty and other privilege schemes.
Luke Lang, co-founder of Crowdcube, says: “Just as we revolutionised equity investment, we are now turning the mini-bond market on its head by taking away the complexity and costs for businesses who want to raise growth capital and cut out the banks, at the same time as presenting a unique way to engage with their customers, encouraging loyalty from existing customers and attracting new people to their brand.”
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