Journalist and accountingcpd.net author, Andy Davis, identifies the most important trends in business crowdfunding.
By Andy Davis
There are obvious answers you could point to – for example, the creation of markets in different types of finance, where multiple lenders can compete to advance funding to a single borrower. This is genuinely new and potentially far more beneficial to the company than the traditional one-to-one relationship between a business and its bank, where the bank sets the terms and the business takes or leaves them. If you believe markets and competition are good, there is much to applaud here.
I’m certainly not suggesting that creating markets in finance isn’t an important trend. It is, but arguably its influence is perhaps a little more limited than is often realised. For a start, the days of unconstrained "Dutch” or reverse auctions – where lenders undercut each other to offer debt finance to companies – may be numbered. Already on debt funding sites where retail investors are active, there is a trend to put in place minimum bid levels to stop borrowing rates being driven down lower than makes sense, given the obvious risks of lending to small businesses.
Funding Circle, by far the biggest SME lending site, put bidding floors in place some months ago and recently raised some of them slightly to keep returns to lenders looking attractive. There is nothing at all wrong with this – it’s all part of the delicate job of balancing supply and demand in a two-sided market that is growing very rapidly. But it does suggest to me that an early and much-vaunted advantage of debt crowdfunding sites may be smaller than was originally thought.
There are at least two other trends that do appear to have genuine longevity, however, and are undoubtedly worth watching.
The first is that crowdfunders eat their chosen market from the bottom up, starting by becoming highly competitive against the banks at small loan sizes and gradually pushing up to take in larger loans as time passes. This process is very clear in Funding Circle’s figures.
Even though the site has now brokered around £180m of lending to British SMEs, the average size of loan that they are taking out remains about £60,000 or so. This means that the heartland of Funding Circle’s lending operation is at the very small end of what it makes sense for a bank to look at, given its very high overheads and the trouble and expense of credit underwriting on such small loans relative to the profit the bank can expect to make from them. So funding circle is colonising its market from the bottom up (exactly as Zopa and Ratesetter have done in consumer P2P lending) and as it grows we can expect to see its average loan size gradually push upwards towards £100,000. The story that process will tell is one of an expanding section of the market in which banks are no longer the default – nor necessarily the most competitive – option.
The second major trend is that business lending is in the process of "going direct” via internet-based operations such as crowdfunders. This trend is already well established in consumer markets such as car insurance, where two thirds of policies are now bought online, but its arrival in business lending – traditionally a market where every business is different and so every loan is a bespoke product – has big implications.
If certain common financial products for businesses (loans, invoice finance, certain sorts of asset finance) can be provided over the internet using a combination of technology and limited human intervention, then the advantages of having a branch on every high street start to look decidedly more limited.
It’s still early days, but these are two of the major trends I’d be keeping an eye on.
Andy Davis's course on Alternative Finance is now available from accountingcpd.net
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