Small businesses are still finding it tough to get loans from mainstream banks, despite the banks agreeing earlier this year to help kick-start the economy by assisting fledgling firms. But while the banks are still closing their doors, some small businesses are finding the crucial cash they need online through the growing phenomenon known as social lending. For individuals who become involved, it can actually mean getting much better returns on your nest egg than with traditional savings accounts.
Small firms are crucial to the country's economic well-being. But without adequate financial help they quickly collapse, meaning lost jobs and unpaid bills. Without a healthy small business environment, the chance of economic recovery is slim, which is why the Government persuaded the main banks – Barclays, HSBC, Lloyds Banking Group, Royal Bank of Scotland and Santander – to agree new lending targets under under the Project Merlin agreement in February.
But on Monday, the first Bank of England lending figures published since the agreement revealed that the banks had failed to keep up their end of the bargain. Total loans for small and medium enterprises (SMEs) in the first quarter of the year came in at £16.8bn. But the banks had promised to lend £19bn. It meant they were £2.2bn off their target. The news prompted anger: "When banks won't lend, small businesses and jobs can't grow," said Lord Oakeshott, a Liberal Democrat peer.
John Walker, the chairman of the Federation of Small Businesses, said: "Unless there is a fundamental shift in the make-up of the banking sector in the UK, small firms will continue to struggle to access affordable finance."
One solution is social lending, also known as peer-to-peer lending, where individuals rather than banks lend to small businesses. The social-lending concept has been around in Britain for more than six years with Zopa (uk.zopa.com) – which brings together people prepared to lend with those looking to borrow – now representing 2 per cent of the UK's personal loan business (see below for more about Zopa). You don't lend the whole amount yourself, but bid for parcels of a deal, spreading your risk among different borrowers.
Apart from the fact that social lending sidetracks the need to use banks, both parties involved can win through the deal. For starters, lenders can get much higher returns on their cash than with traditional savings accounts. At Zopa, average returns on the last year have been 7. 3 per cent. Meanwhile, borrowers can get much cheaper loans. Zopa reckons the deals offered through its site are at least 20 per cent cheaper than the best rate a borrower may be offered at a bank.
Last year saw the concept taken a stage further with the launch of the Funding Circle (www.fundingcircle. com). It allows individuals to offer money to businesses and, as well as decent returns, those lending know they are helping firms, often at a crucial time. Two-fifths of companies that have borrowed through the Funding Circle have done so to either expand or for growth capital, while a third did so to generate working capital.
"It's a simple proposition which allows individuals to maximise returns on their hard-earned cash whilst also allowing businesses of all sizes to borrow at lower rates than those set by the banks, with a quicker turnaround," explains James Meekings, co-founder of the Funding Circle. In the first six months of setting up the site, people who have signed up as lenders have offered more than £11.5m to businesses, and have collectively earned an average yield of 8.3 per cent.
Meekings says new members tend to start small, putting in just a couple of hundred pounds or so, then get more involved as they get used to the concept. "Since its inception, when accounts were typically opened with £500, individuals have realised the potential of the platform and have increased their account size to an average of £3,500," he says.
Lending to small firms is a risk. If cash-flow problems hit, they can quickly go under, meaning loans are defaulted. For that reason, the Funding Circle suggests members spread their loans across 20 different deals. But they say that since being launched last August, they have not yet had one loan default. The deals are also flexible, meaning that you can sell on your loans to other members, giving you access to your cash if you need it in an emergency. "On average, it takes just two days to access your money with us," says Meekings.
The Funding Circle is still relatively small. It has 4,000 members who have helped 152 businesses across the UK. In the first eight months of trade, collectively the members offered more than £13m for businesses to borrow and made interest of almost £120,000 from completed loans. The site is currently lending almost £1m to small firms each month. In the wider economy and the problems small companies have in raising finance, that is small beer, but the potential is there for the concept to grow and become a real alternative to unhelpful banks.
"Small businesses are keen to grow: they've come out of the difficult period and want to thrive," says Meekings. "But the cost of a loan is still a major issue for businesses. Although banks may offer a loan to a small business, it is often at an extraordinarily high rate. Because we're online our loans can be much cheaper, from 7.3 per cent.
"However, we can't help small businesses alone – the banks have to get their act together."
'Everyone wins, except the bankers'
Peer-to-peer lender Zopa launched in the UK in 2005. Its proposition was simple: savers get a better return on their money by lending it to creditworthy borrowers through Zopa, and everyone wins, except the bankers.
Borrowers and lenders effectively agree the rates at which they do business themselves, with no bank involved, which means that rates can be set at a level that both parties are happy with, rather than a bank dictating what rate it will lend at.
Lenders win as they get a much better return than they would from a savings account (on average 7.3 per cent after charges over the last 12 months) and borrowers typically get the loan they are seeking for 20 per cent less than the best rate they can find from a bank.
Zopa does all the credit and affordability checks on borrowers and has managed credit risk well enough: the default rate on Zopa loans is just 0.8 per cent, the lowest of any unsecured loan book in the UK. Zopa also reduces risk for lenders further by automatically spreading lenders' money (above £500) across at least 50 borrowers. Unlike the current banks' spread of more than 12 per cent, Zopa charges lenders just 1 per cent of the money they lend each year and borrowers pay a flat fee of £130 for each loan which is reflected in the APR.
Giles Andrews, above, co-founder of Zopa, says: "Just this week, banks are now charging the highest average rates on personal loans since 2000 – 12.7 per cent. With loans available for the lowest risk borrowers at Zopa for as little as 7.1 per cent, this new way to borrow and lend offers both sides of the equation a refreshing alternative to getting ripped-off by the banks."
Case study: 'I like being proactive with our cash'
"I believe my money should be working for me rather than sitting in the bank," says IT consultant George Hayward. The 40-year-old has become a big fan of social lending, increasing his portfolio of loans on the Funding Circle website from £400, when he first started last November, to £5,000.
"In the past we've put our cash into buy-to-let and now have four properties, but we like to spread things around to give us a more varied portfolio," George says. His wife Amy, 32, came across the Funding Circle online and suggested it as a potential home for some of the family's savings. "Amy did a lot of research on it as we were looking to get better returns on our savings than we can with ISAs," explains George.
"I liked the concept as I like being proactive with our money. I pop on to the site up to three times a day to see what deals there are. Because I work in IT, I can find the five minutes or so it takes each time. My average return is 9.3 per cent, but I bid on almost everything as sometimes borrowers just need a small parcel to complete their loan amount so, if you catch it right, you can get a better rate."
George holds 40 loans, but likes to sell them off to other members of the site to make a quick return. "I have invested in shares before but I don't like the lack of control. There are too many factors involved that you can't do anything about. Things would happen and I wouldn't be able to find out why. I learnt that the only people who make money when shares drop are brokers, who still get their fees."
While he is a fan of the Funding Circle, George concedes that it may not be for everyone. "I take a very active role and enjoy it, but I know most members just use an auto-bid feature to set up their deals," he says. He knows that there are risks in lending to small businesses but to date, the rewards have been worth it. "I've only seen one company miss a payment, and they were consistently a late payer, so it was no surprise."
The Funding Circle says it only deals with businesses that have been established for at least two years, that have a solid financial track record and that can prove that they can repay a loan with their projected cashflow.