On the face of it, borrowing money to start a business should be becoming much easier. Under the ‘Project Merlin’ agreement with government, the majority of UK banks have agreed to lend a targeted £76bn to small and medium-sized companies, and figures published in August suggest they are more or less on track to deliver on this promise.
Meanwhile, the Bank of England has pledged to pump a further £75bn into the coffers of banks and insurance companies via its quantitative easing programme. With more cash available, financial institutions will be better placed to go on lending to their business clients.
So does this mean the credit crunch can be officially declared over? Sadly no. In the first half of the year, the banks taking part in Project Merlin lent a healthy £37.5bn to businesses classified as ‘SMEs’, but that doesn’t tell the whole story. All over the UK companies are still struggling to secure loans, with young and start-up businesses being particularly badly affected.
Put simply, these days banks don’t like risk and that’s bad news for young companies. If your business has yet to file accounts or has a trading record of just a few years, the banks will consider you a very risky project. And if you’re still at the pre-revenue stage the perceived risk rises through the roof. The caution of banks can slow down the whole lending process. Even if a bank does eventually advance the cash your business needs, the gap between the initial application and the green light can stretch to months. And once the loan has been approved, the interest rates and fees could well be forbidding.
But banks are no longer the only game in town. One of the by-products of the funding gap is the emergence of new models of business funding – some of which can be particularly useful to young companies that are failing to make much headway with the banks.
We spoke to three new players in the market: borro.com, MarketInvoice and Funding Circle – along with companies that have used each service to raise finance – to find out how each model works, what it costs, and crucially, how viable it is for a start-up business.
borro.com: Borrowing against assets
Founded three years ago by Paul Aitken, borro.com advances cash against valuable personal assets, such as jewellery, fine wines and classic cars. Essentially, the company is a business-friendly variation on the age-old pawn shop model. In order to access cash, you agree a value for your car or rings, and hand the items over to the provider. They can be retrieved once the loan has been paid off.
According to founder Paul Aitken, it’s a lending model that is ideal for businesses that need rapid access to cash to pursue an opportunity or pay a bill. If you need £10,000 to buy stock, kit out a retail space or even pay the taxman, borro provides a means to get the money within the space of a few days.
One reason borro can advance cash so quickly is that there is no need for lengthy credit checks or examination of your business plan and accounts. Put bluntly, borro doesn’t need to know anything about your business as its investment is secured against the assets that will sit in its storage facilities until the loan is repaid.
Businessman Terry Voce, founder of A&T Food Services, confirms the rapidity of the Borro model. Needing cash to start his business, he raised £12,000 against watches, gold, diamond and silver within 24 hours of applying. “There was none of the hassle I would have experienced if I had gone ahead and applied for a bank loan,” he says.
Meanwhile, the sums raised can be substantial. “The average loan value is about £4,000,” says Aitken. “But we can go as high as £1m.”
Here’s how it works: Borrowers can approach borro either through the website or via a financial adviser. The first step is a 10 or 15-minute conversation, during which borro will discuss the available assets and assess whether it will be possible to provide a loan.
The next step is valuation. “Let’s say it’s a classic car,” says Aitken. “We will collect it and value it and make a loan offer.” Interest rates are set at 2.49% per month and the average borrowing period is four to five months. There is no requirement to repay any percentage of the loan before the end of the agreed period, although customers can make the payment early without incurring penalty charges.
However, Aitken stresses that borro is ideal for businesses that need a short term cash injection. “It’s not for long-term finance,” he says. “If you need money over the long-term you need finance that’s appropriate for that.”
MarketInvoice: Using debtors as collateral
One of the biggest challenges facing new businesses lies in managing the yawning gap between the sending of an invoice to a customer and the receipt of payment. Depending on the terms of the agreement – which are often dictated by the customer – the period between bill and payment could be anything from a few weeks to several months, and during this time you’ll have to pay bills and wages. It can be a long wait.
And also a real financial problem. Unless you have sufficient cash in the bank, you can find that your business will simply run out of money, even though you’ve got plenty of customers. As such, many businesses rely on bank finance to ensure they have enough ‘working capital’. The traditional financial tools for this purpose are overdrafts and ‘invoice finance’, which enables you to borrow against the value of invoices once they are sent to customers.
However, in the current climate banks and specialist invoice finance providers won’t necessarily lend to start-ups and very young businesses. And those that will tend to limit their offer to factoring arrangements, which will mean the lender collects all the debts from customers on your behalf. Handing over debt collection to a third party isn’t always comfortable and in addition, most factors will require you to sign up for a specified period (locking you in to fees and charges) while also putting a limit on credit.
MarketInvoice offers a flexible alternative. The company operates as an online marketplace, bringing together investors who lend money with businesses in need of finance. It’s a variation on the invoice finance model, but in this case a company can pitch for funding on individual invoices. Thus, if your business has secured an order worth £20,000, you can present that to investors on the market and raise cash against it. You use the system when you need it, collect your own debts – thus maintaining a relationship with the customer – and you’re not locked in. “And because we have multiple investors, businesses can get the best rates,” insists founder Anil Stocker.
There is a one-off vetting process. MarketInvoice will ask to see company accounts and a debtor ledger but if everything checks out, you can be using the marketplace within 48 hours. Once you are, you’re into a bidding process. The company specifies the percentage of the invoice value required and a minimum and maximum fee (say 1.5% to 2.5%) that it is prepared to offer to investors.
The company can also specifiy a fee level that it will automatically accept. Bids flow and the company chooses the best rate. MarketInvoice takes an additional 0.5% fee. The finance available is dictated by the size of the invoice, and cash is repayable once the invoice is honoured.
According to Joseph Miles, it’s a system that can be particularly useful for businesses that are growing rapidly. As MD of social media marketing company XI Backoffice, he found that as his business expanded, the cost associated with providing services for an ever-growing client list were not covered by revenues earned in previous months when turnover had been lower.
The banks, he says, were not helpful as they based their lending limits on old and out of date trading figures. “They have fixed rules. They wouldn’t give us the factoring facility we needed – even though factoring is not intrinsically risky.” In contrast Miles found he could raise the money by pitching to MarketInvoice investors.
Stocker says MarketInvoice can help start-ups and young companies. However, those pitching should be aware that fee levels will reflect the investors’ perception of the risk.
Funding Circle: Term loans from individual lenders
Like MarketInvoice, Funding Circle offers an online platform that puts small businesses in touch with investors who will lend money. However, Funding Circle’s focus is on term loans that will be paid off over a specified term – typically one to three years.
To qualify to raise cash via Funding Circle your company will need to show two years’ worth of accounts filed at Companies House, so it’s not for start-ups. However, allowing for the time lag between a trading year ending and accounts being drawn up, businesses as young as two and half to three years can participate. The sums advanced range from £5,000 to £100,000.
The average interest rate is currently 8.4%. However, because money is advanced on an online auction basis, businesses perceived as less risky or particularly attractive can secure better deals. This was certainly the experience of Richard Curtis, owner of Brighton-based Coffee Rites – trading as the Ground Coffee House. He raised £40,000 to open a second coffee house and as he explains: “When the bid goes up you can see all the trading and you can watch the numbers shifting. Towards the end of the process lower bids came in and those automatically knock off the offers with higher rates.”
According to James Meekings, co-founder of Funding Circle, around 40% of the loans secured through the marketplace are to fund growth, but investors will support pitches from companies seeking cash to manage working capital.
The key to the market’s success in matching lenders with borrowers is a thorough underwriting process that ensures participating companies are good credit risks. This has attracted investors who see it as a means to get a good return on their investment – particularly at a time when interest rates on savings accounts are at an all-time low.
As the financial squeeze continues we’re likely to see more innovative forms of finance emerging and the three profiled here are part of a much larger picture. This can only be a good thing, as it gives young businesses looking for start-up funding or growth capital a wider set of options.
Startups will be bringing you more information on alternative funding models and providers in the coming weeks. Watch this space...