Where small businesses can borrow if the banks turn them down
BANKERS ARE CONSERVATIVE types. It is hard to imagine any of them jumping at the opportunity presented by Ryan Grepper, an Oregon-based “part visionary, part mad scientist, and a passionate supporter of the DIY revolution”, to lend him $50,000 to develop an oversized picnic cooler. Not just any cooler, mind you, but The Coolest, which beyond keeping drinks chilled also blends them, blares music and recharges gadgets. But what bankers would surely have disdained, the public seized with gusto: last August Mr Grepper raised $13.3m from Kickstarter, a crowdfunding platform, over 250 times what he had asked for. None of the money he has received will ever need to be repaid, either. Instead, the first 63,380 coolers he makes will go to the backers who put up around $180 each, with luck in time for the summer picnic season. A few will be hand-delivered by Mr Grepper, who offered personally to man the party bar for anyone who pledged $2,000 to his venture.
Financing small businesses is rarely this colourful. A few consumer-friendly ventures like The Coolest aside, corporate minnows have been struggling to raise money in recent years. The buoyant bond markets that have allowed large companies to borrow at rock-bottom rates do not cater to their smaller cousins. Banks have cut back on lending to small businesses as regulation has made it less lucrative. And since the due diligence needed to extend a $20,000 business loan takes nearly as much time as that for a $2m one, they have tended to concentrate on the bigger fish. A range of fintech ventures have popped up to try to fill the gap.
Some are akin to the peer-to-peer platforms that have done so well in consumer lending. Funding Circle, a British startup that is also active in America, advertises itself as “the bond market for small companies”. It has disbursed nearly £600m of loans in Britain, some of them financed by government agencies. But applying fintech’s data-guzzling model for consumer lending to small firms is tricky. There is far less readily available information to help gauge a business’s creditworthiness than there is for a person’s, says Samir Desai, the startup’s boss. What can be discovered, from tax records and regulatory filings, is often of poor quality or well out of date. Funding Circle’s method includes a step that would be considered retrograde by fintech purists: a flesh-and-blood credit agent from the company speaks to every new borrower before a loan is disbursed. Its pitch to borrowers is as much about convenience—the application process is less onerous than that of a bank, and borrowers get the money faster—as about getting better rates.
Peer-to-peer lenders to businesses, unlike their equivalents who lend to private individuals, do not have an obvious entry point such as credit-card debt that can be refinanced more cheaply. That makes it harder to acquire new customers. Many borrowers turn to peer-to-peer only after their bank has rejected them. In America, OnDeck, a platform that listed last year, has had to bat away suggestions that it is over-reliant on loan brokers, which charge hefty fees to bring in businesses looking for quick cash. And processing the applications can be fiddly, too, particularly when loans are secured against the borrower’s personal assets. On the other hand, usury laws that cap interest rates for consumer loans do not apply to business credit, so rates can be higher. OnDeck’s average interest rate is reportedly over 50%.
Lending Club, the industry’s biggest firm in personal peer-to-peer credit, is edging into business loans. In February it started offering American businesses up to $300,000 to finance purchases made on Alibaba, a Chinese online marketplace. The money is not secured against the merchandise, but the fact that a business has verifiably just purchased widgets from a Chinese factory strongly suggests it will soon be earning some money from widget sales.
Kabbage, a rival based in Atlanta, specialises in lending to businesses that do most of their selling on e-commerce sites. It thinks it can work out who is a good credit risk by looking at a vendor’s eBay sales history (and the accompanying reviews) in a way a bank cannot, or cannot be bothered to.
New models are emerging. Last year Square, a company that enables small businesses and individuals to process credit-card payments, started offering cash advances to some of its customers. As it has ready access to several years’ worth of a merchant’s payments data, it can take an educated guess at the likely future cashflow. Better still, because it will process the payments from which its advance will be refunded, it can withhold the cash at source. For a $10,000 loan, say, Square will take a 13% cut of card sales until $11,300 is reimbursed. Elegantly, though all customers end up paying the same $1,300 of interest, the interest rate will depend on how long it takes each borrower to repay the loan. The faster he sells and the faster the loan is repaid, the higher the effective rate. Borrowers eager to maximise their sales do not seem to mind. The average repayment period is about ten months. PayPal, a payments giant which is currently being spun out of eBay, is now offering a similar service to its merchants.
An invoice worth its weight in gold
Small businesses would love to be able to monetise what is often one of their biggest assets: the money customers owe them. Most of them have to wait for 30-90 days after they have dispatched the merchandise before getting paid. A slew of smaller (and sometimes not very savoury) finance houses have traditionally offered to buy the outstanding invoices at a discount, paying perhaps 60 cents on the dollar. Leaving aside the risk of fraud, the paperwork was daunting.
By moving invoices onto electronic platforms, fintechers hope they can make the process frictionless. A plethora of such platforms are competing to make e-invoicing the norm. If a local business sells a shipment of ball-bearings to Ford, say, and the carmaker agrees electronically it will make good on the invoice within six weeks, that makes the invoice nearly as valuable as a Ford bond. It might be worth 98 cents on the dollar, not 60. The verified invoice can then be auctioned on a platform, or packaged up into the sort of security investment bankers clamour for. By turning the invoice into a fungible security, the local business in effect piggybacks on Ford’s credit rating, which is likely to be much better than its own. In practice, the process remains fiddly for now. Nor is this a business that banks will give up easily. They typically offer far better rates on business loans they can secure against invoices, if only because regulators treat such lending more leniently than unsecured credit.
None of these financing options are viable for businesses just getting off the ground. In Britain, those with a good story to tell (and preferably a photogenic founder) can turn to one of dozens of equity crowdfunding platforms to drum up some cash. Crowdfunded equity money usually involves handing a stake in the business to the new backers. Nesta, a charity, says the British public invested £84m in such ventures in 2014, up over 400% in a year—even though the Financial Conduct Authority has warned that investors taking small stakes in budding businesses are “very likely” to get wiped out (tax breaks may ease the blow).
In America, the time-tested method of a plucky entrepreneur maxing out his credit card is still a rite of passage. That may be about to change. Rules that currently restrict investing in startups to investors with a net worth of $1m or an annual income in excess of $200,000 will be scrapped later this month. From then on anyone will be able to try their luck at crowdfunding. That is good news for those who want to invest in Mr Grepper’s next offbeat venture and get a piece of the action, not just a deeply chic picnic cooler.