It’s no surprise that Funding Circle, which enables individuals and organizations to lend to small businesses, has attracted $58 million in funding from venture firms Accel Partners, Index Ventures and Union Square Ventures.
According to its calculations based on Bank of England statistics, extending credit to SMEs is a £7 billion-a-month market in the UK alone.
Funding Circle and more than a dozen other UK companies are filling a gap: according to NESTA, an organization working to increase innovation in the UK, demand for alternative sources of finance in Britain grew by 91% between 2012 and 2013 because traditional leaders are not serving SMEs’ needs.
These disruptive companies are part of a new generation of London start-ups that are grabbing customers from traditional financial services companies or, in some cases, trying to figure out ways to work with them or sell to them. In addition to lending, these startups are targeting faster, cheaper, better ways of banking in all its forms.
There are plenty of reasons why London serves as a magnet for fintech companies: it is one of the world’s leading financial capitals, and considered to have a far more international scope than either New York or Singapore. Some £4 trillion of assets are managed in the UK. And financial services represent the country’s single largest sector by GDP.
London’s Position As A Global Leader In Fintech
“All the ingredients are in place for the UK to maintain its position as the world-leading destination for fintech growth,” says Eric Van Der Kleij, head of Level39 in Canary Wharf, which bills itself as Europe’s largest fintech accelerator.
“London’s enviable position as a global financial capital has created, over time, a unique and progressive legislative environment for financial services and tech companies. When this legacy is coupled with London’s ever-growing status as an international tech city and huge tech talent pool, it is easy to see why the UK is the optimized location for an aspirational fintech company to expand.”
London isn’t only considered optimal for fintech start-ups: UK-based venture-backed tech start-ups raise more money than those in either France or Germany and over the past five years there were more exits by UK companies and the average deal size was greater. It is no wonder then, that the city is a magnet for aspiring entrepreneurs from across Europe and beyond.
In an attempt to seal London’s place as the tech capital of Europe, start-ups in fintech, as well those targeting education, government, music, sport and science, will be showcased in June as the UK capital holds the first London Technology Week — which is expected to attract some 30,000 attendees — from 16-20 June.
Of all the sectors London start-ups are targeting financial services are perhaps the most ripe for disruption. Lending is a case in point.
Don’t Expect Banks To Catch Up Any Time Soon
Traditional banks are reluctant to make loans to small businesses because the math just doesn’t add up, says Udayan Goyal, founder of the Anthemis Group, a financial investment and advisory firm. Banks have antiquated processes in place that require manual collection of data that must be collated, entered into the bank’s systems and indexed — a process that can take days to complete. The process is not just time consuming — it’s expensive, costing around £5,000 to underwrite a £10,000 loan. “For a mid-sized to large bank the question is why should I process a £10,000 loan at a cost of £5,000 when for £20,000 I can underwrite a £15 million loan?” says Goyal.
Fintech start-ups are able to automate the process, slashing costs. “If the comparative cost is £200 it is not a problem to write a £10,000 loan,” says Goyal.
While it can take banks days, if not weeks, to approve a loan, fintech start-ups can offer quick access to cash. Just Cashflow, for example, claims it will make a decision within six minutes. And Everline, part of the Wonga Group, is even faster, saying it can make “a robust, responsible decision within a nanosecond.” Everline digitally “draws on all of the information available — there is a lot of data out there — to get an indication of how good the business is,” says CEO Russell Gould. “We had no defaults in the first 12 months.”
Don’t expect banks to catch up any time soon. “It is quite hard for the banks to find a new way of processing loans as it requires significant change in systems, to collect and process data and also in the processes, which means they have to retrain people,” says Goyal.
Lending to SMEs by banks participating in the UK’s Funding for Lending scheme fell by £723 million in the first quarter, according to reports. That poses a problem for the UK economy because SMEs account for some 99% of UK businesses and nearly 60% of private sector jobs.
The Government Plans To Take Action
In the legislative agenda laid out in the Queen’s Speech to Parliament on June 4th, the government announced a bill aimed at making it easier for SMEs to access finance. It is also anticipated that the bill will include laws that compel banks that turn down businesses for loans to inform them of alternative sources of finance, such as invoice finance and peer-to-peer lending.
Invoice factoring and invoice discounting both fall under the heading of invoice finance, the ability to raise cash against the value of invoices. Both invoice discounting and factoring generally require fewer personal liabilities than most traditional forms of lending, as cash is secured against the future payment of invoices. Factoring has been around for a very long time. What’s new is doing it digitally and more flexibly. MarketInvoice, for example, offers funding with transparent rates, no lock-in period, no debentures, and with no requirement to put all invoices through the platform.
Invoice financing, which has come from both the UK government and institutional investors, has been channeled to over 500 businesses up and down the country, giving them working capital to grow.
And Capital Aid, which launches in June, is aiming to make the process seamless by offering SMEs using the social e-invoicing platform Tradeshift loans via invoice financing at the click of a button, says Capital Aid CEO Torben Pedersen.
App developers can also — for the first time — use a type of invoice finance to get faster access to their app store revenues, which can then be used to accelerate their growth and installed base, thanks to Pollen, a new service launched by Martin Macmillan, a former bond trader.
Global Peer-To-Peer Lending Will Reach $1 Trillion By 2025
Peer-to-peer lending is another, increasingly popular way for SMEs to obtain loans. Research estimates that global peer-to-peer lending will reach $1 trillion by 2025. The total amount of money lent through UK peer-to-peer lending to date is an estimated £1.5 billion. Funding Circle says it has so far enabled 30,000 investors (including the public sector) to lend £285 million to UK businesses; £130 million was lent out in 2013 alone. In October the company merged with San Francisco-based Endurance Lending Network, following a $37 million round. While the UK market opportunity is big, the U.S. is more than twice as large.
Like many of the London fintech companies extending credit to SMEs Funding Circle has global ambitions, but it says the UK has not gone far enough to foster the burgeoning fintech sector.
“The tax system to encourage entrepreneurship to start businesses in the UK is probably market leading; the tax system dealing with our actual product is not,” says Funding Circle’s Desai.
While the UK government is encouraging individuals to invest in SMEs, “when they step into the shoes of a financial institution they are materially in a worse position then if they were a bank,” says Desai. For example, if an individual loans £100 and makes £10 on one deal but loses £11 on another he will still be taxed on the £10. A bank would not.
If the UK is serious about being a global hub for fintech, it needs to level the playing field, Desai says. “We may be global leaders but that won’t last very long unless there is fundamental reform of the tax regime.”