Peer to peer loan descriptions: What’s in a name?

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I’m an avid reader of the Lend Academy blog by Peter Renton, in fact, I recently reviewed his book about Lending Club, The Lending Club Story on the Funding Knight blog.

One of the reasons I love Lend Academy is the amount of information and analysis on offer for P2P enthusiasts.  Yes, it’s focused on the US market but it never fails to get me thinking…

This week, it’s the a guest post called Loan Descriptions – Can They Be Helpful When Choosing Loans? that has caught my eye.  Written by Sam Kramer, a financial sector old-timer and keen P2P investor (You can find him on Twitter @P2P_CT), the post delves into historical data to investigate whether the loan description that introduces a P2P loan is at all predictive of its eventual repayment rate i.e. can you predict which loans will default simply by reading their name?

Well, I won’t let all of the results out of the bag, you should head over to Lend Academy to read the full post for that (and subscribe since this is just the opener in a 2 -part guest slot) but here’s a taster to whet your appetite.

chart tracking default rate by loan description length

Default rate by loan description length

Top level analysis: Very short loan descriptions (between 1 and 10 characters) have a reasonably high default rate.  (Note, interestingly, no-description loans have a lower-than-average default rate, as do short loan descriptions of 11 – 350 characters).

The post goes on to look at the impact of longer descriptions as well as drawing attention the the impact that recency of loans will have – if no-description loans are a relatively new thing, then logic says they’ll have a lower default rate since less of them will have grown to maturity.

This latter point is relevant for virtually every piece of analysis you’ll see about peer to peer lending as the whole industry is so young.  Finding a way to compare default rates of very young ‘unseasoned’ loan books with the much more mature lending portfolios of mainstream banks could throw up some interesting analysis… any volunteers?

A simple guide to peer to business lending: Timescales and security…

So I’m beginning to understand the basic processes and some of the jargon behind crowdlending. As a complete beginner to all this, its not actually as complicated as I first thought.

Last time we established it wouldn’t cost me anything to lend money and invest into FundingKnight. In fact by investing, I would hope to see some returns on my investment. There are no fees to become a peer-to-peer lender and I can set my own interest rates for those to borrow against. On the other side of the process, as a borrower, I would expect to pay between 7 – 12 % interest on a loan I take out plus their arrangement fees (check out www.fundingknight.com for full details). So far, so good. Learning is good.

Now what about timescales? If I lend to FundingKnight, how long would I need to invest my money for? Is there a set amount of time? Or can I access my cash whenever I need it? I asked the bigwigs for some answers…

FK: Our loan exchange will let you sell all or part of your investments on to other people.  So that means you get to combine the benefits of making your cash work harder (than it typically would in an easy access savings account) with access to your money – selling your loan can help you get at your cash if you need it.

KK: so I can basically forward my investment onto someone else and get my money back if I need it. What about security? With all the crazy happenings of the past four years, would my money be protected against an unpredictable market?

FK: The Key difference between crowdlending and bank or building society accounts is that there is no safety net so, however successful crowd lending becomes it will never be the same as putting your money in the bank.  What it does do is offer you a chance to invest in businesses you believe in, support values you want to promote or choose to lend locally within your own community.

In all honesty you shouldn’t use peer to peer lending to invest money you can’t afford to lose but, that said, all of our borrowers have to supply all sorts of financial information and are put through external credit checks in addition to our own in-house analysis.  The FK management teams are investing in all early loans themselves so they have an added incentive to get things right.

KK: Ok, fabulous, I can see how crowdlending makes much more sense to me as someone who tries to live ethically, pursues an active interest in their community and local businesses. It ticks many boxes that you wouldn’t find elsewhere, especially not at a run of the mill high street bank. It seems to me that there is a whole world of opportunity out there that I am beginning to learn about. Stay posted.

Crowdlending vs. crowdfunding… what’s the difference and why does it matter?

blackboard with the word 'debt' written on it

Crowdfunding has become a hot topic recently and the news that Kickstarter has will officially launch its UK operation at the end of this month means that it will probably stay in the headlines.

Whilst the concept is still relatively new in the UK, Crowdcube (the UK’s biggest crowdfunding website) has helped to raise £4 million for small businesses and Seedrs – the first UK crowdfunder to be regulated by the FSA – has a target to help 400 business raise cash from private investors each year.

There is a genuine surge of interest in alternative finance and for many the idea of ‘owning’ a part of a start-up seems really appealing.  Frequently the chance to support an appealing new business idea is a stronger motivator than the potential financial return.  There is a “community funding” aspect to crowdfunding, as it tends to select the businesses that are perceived to benefit people.

So, that’s crowdfunding; Basically the process by which a business, which is often – but not always – a start-up raises funding in return for some type of equity deal or reward.

But what about crowdlending?

Well, we started using the term crowdlending to describe FundingKnight just after writing this blog post on whether peer to business lending needs a new name? (Which in turn took inspiration from the Lend Academy blog in the US)

The key point about crowdlending is that no equity changes hands.  FundingKnight lenders, or those using other P2P websites to lend to individuals or businesses, simply provide “loans”.

In return, they get a rate of return on their savings which very often beats that available from traditional easy access savings accounts (which right now are struggling to beat inflation!)  They take no share of the company, have no say in how the company is run and have no voting rights or other control over day to day operations.

So, why might an independent business that’s searching for business finance prefer to take a loan – otherwise known as “debt funding” rather than sharing out equity in their company.

Knowing that it’s a topic close to the heart of FundingKnight’s founder and CEO, Graeme Marshall, I asked him to share some of his thought on why debt can sometimes trump equity when it comes to funding a business.

Here’s what he said:

“I often see company’s approaching Angels for equity when they really should be looking for debt.  It was one of the reasons I started FundingKnight.  Why would someone running his own business want to burden himself with outside shareholders whose agenda will almost always be different from that of the owners?”

So that’s the first key difference between crowdlending and crowdfunding:

Crowdlending = Lenders make loans and borrowers pay them back.  No shares change hands, no control of the business is given up.

 

Crowdfunding = Investors provide a cash injection in return for equity in the business or some other reward.  Usually, they will then have a say in the future of the business / how it is run.

Next, comes the question of what happens when investors – or lenders – want their money back?  It’s a reasonable question since, after all, circumstances change for all of us.  Today’s rainy day fund is tomorrow urgent repair fund so having a way to access an investment is pretty fundamental.

When it comes to business finance, Graeme says,

“The key question is “how is the equity going to be turned into cash?”  Ideally, Shareholders need to be aligned on this point.  If not, there needs to be a clearly understood strategy setting out how new shareholders are going to get their cash.  Listed companies whose shares are traded avoid this problem…. Private companies are a minefield!”

So, there’s the second real difference:

Crowdlending = A scheduled plan of regular payments is agreed upfront detailing how a lender will be repaid their capital + interest.

 

Crowdfunding = Every business needs its own strategy for how shareholders can realise their cash… and not all shareholders will agree on the best way to do this!

 

And that’s why Graeme believes that profitable businesses who are expanding should look to borrow first:

“If the cash required for expansion is to turn into profitable sales of goods or services, they should have the means of repaying the loan out of these profitable sales.  It’s also a good discipline on a company, as if they are not generating the cash to service a loan, is the expansion really profitable?

At the end of the day, every business who borrows money needs to know how they will pay it back.  If you can’t see this clearly, but the cash you need it clearly building long term value, you need equity.”

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Crowdlending needs a crowd of accountants to help advise small businesses

dictionary definition of tax

Michael Izza, CEO at the ICAEW wrote an interesting blog yesterday about why we need one body for business support in the UK.

He praised the recent efforts of government to help boost small business funding but warned those in search of small business finance not to “be surprised if you haven’t heard of them.  You have to apply to lots of different places to get them…. It’s a bit of an alphabet soup of measures.”

Michael Izza kindly went on to provide a quick run through of the governments business support measures, well worth a look if you are looking for business assistance, and shared his hopes that the launch of the Small Business Bank will help gather all of these resources into one, easy to access, place.

We certainly hope that the Small Business Bank improves things.  After all, funding for business means boosting the entire UK economy.  One person’s business loan becomes another person’s route to employment or orders and so on and so forth.

A bank will help but there will still be a lot of advice needed by independent businesses trying to navigate through rough economic conditions.

Accountage Age picked up on the words of the ICAEW chief in their own blog which added the stat that “a third of SMEs were failing to take advantage of tax breaks available to them, with the same proportion unaware of tax breaks potentially beneficial to them.”

Whilst a business bank might help boost lending, accountants will remain the absolute lynchpin of the small business community.

It is accountants that have the real ear to the ground experience that small businesses value.  It’s accountants that have the expertise to provide advice across all manner of business finance issues, be they funding, tax or simply regular book-keeping and it’s accountants who can really help businesses make the most of alternative finance like crowdlending.

That’s why we’re asking accountants to register with us as an advisor. We think the future of new finance is bright, but it’s a future that needs us all working together.

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We like… West Country Radio

One of the reasons we set up our crowdlending business was to provide a way for people to invest in the things that are important to them. You see a business model you like, an ethical standpoint you admire or simply a gap in the market and then invest into a company that fits with your beliefs. You have the power to make good things happen.

As we build up our business we hope to make that dream a reality but in the meantime, we’re keen to help local causes in whatever way we can.

Over the next few weeks, we’ll be looking at business models we admire, want to be involved in or just think are worth sharing. We’ll also follow progress as these companies grow, taking our readers, lenders and investors on a virtual journey.

First out the bag is West Country Radio. Just launched on 13 August 2012, their business is a not-for-profit radio station aimed at promoting the south-west, increasing tourism and promoting businesses, resorts and events. It is a local business aimed at improving the lives of local people.

Its uniqueness comes in the form of how the radio station is broadcast. All presenters broadcast from home studios, transmitting their shows live and pre-recorded. This of course reduces costs enormously and allows money acquired by the station to be used on other things such as marketing and promotion.

What’s more, the station is completely run and produced by volunteers, minimising costs and providing fantastic volunteer opportunities, internships and training for people keen to get involved and learn about how a radio station works.

Opportunities like these are incredibly valuable for a local community and are applicable to all ages, from young people looking to gain experience for the future through to retired volunteers looking to give something back in their spare time.

Whilst relying on volunteers and therefore reducing overheads considerably, West Country Radio are also looking for funders, advertisers and sponsors to aid and increase capacity and grow the station’s listenership. The hyper-local nature of the station means that local businesses and events would benefit enormously from getting involved in the station whilst also helping out in the early stages of growth and helping to benefit the local area.

Local ventures such as West Country Radio are exactly what Funding Knight want to promote. Sometimes, we’ll help by providing business finance via our crowdlending model, and when that’s not viable we’ll help spread the word about local people committed to helping local people. We believe life is about more than just business, it’s about getting back to the roots of community and the warm fuzzy glow you can get as a result.

Business finance: A load of shylocks or simply a sector dying to change

street sign for 'Change Alley'

I read an interesting article this week from Nasir Zubairi, Head of Product Marketing at the Currency Cloud.  His post, Selfish Shylocks, published via the Huffington Post, takes a look at the state of innovation – in general – and the lack of innovation – specifically – in the banking sector.

He makes some really good points, explaining that:

  • Innovation improves the status quo and substantially alters it
  • Innovation focuses on making things better for customers

But he also laments the fact that, in general, UK banks have a. forgotten to share the benefits of innovation with their customers and b. tried to avoid any sort of innovation that promotes anything other than higher profits.

In seeking to explain why the big banks get away with it, Zubairi quotes the stark statistics that prove how remarkably un-elastic customers are when it comes to financial services.  “Out of 64 million bank accounts in the UK”, he tells us that “less than 0.1% have voted with their feet and shifted banking provider in the four years to the end of 2011.  Even then the likelihood is that the switch was to one of the other three big banks.”

The rest of the article rightly applauds some of those at the frontier of new finance.  I agree that new entrants such as Bank Simple, Holvi, Movenbank and The Currency Cloud represent the future of finance but it’s probably also worth asking why now? What needs to change?  What will make people vote with their feet?  Why will things ever be different?

And to answer those questions, I’d add another point to those above describing innovation.

Innovation frequently happens when developments in products or services coincide with some bigger, more important change in the way we collectively live our lives.

The i-pod didn’t create digital music.  The i-phone didn’t invent the smartphone.  Rather they are examples of great product design that came along at just the right moment to capture the public imagination.

It might seem ridiculous to think that something similar could happen to the banking industry, to a sector characterised by complexity and – let’s be honest – boredom.

But, honestly, I really do think something is starting to happen.

Over the summer, I read a book by Harvard professor Youngme Moon called Different. Escaping the Competitive Herd. Standing out in a world where conformity reigns but exceptions rule.

 

Apart from being amused by the very length of that title, I was struck by how relevant the last bit is to what new finance is trying to achieve.

“Standing out in a world where conformity reigns but exceptions rule”

Surely, that sums up where new finance is at right now?

Moon makes some fantastic observations about why the time for change is now, and has already begun.  She notes that many “businesses have forgotten the point of it all – which is to create meaningful and compelling product offerings.”

So can banking – lending or borrowing money – be meaningful?

Yes.

I’ve already explained why I think new finance is more than simply a romantic notion and I wholeheartedly agree with Moon that the global recession has set the wheels of change in motion; “the storm (has) refocused us all in some collective way… even those who were financially secure have begun rethinking their most basic consumption patterns… the age of abundance is over. Not because things are no longer abundant, but because abundance has lost its status as our reigning aspiration.”

So, new finance.  Innovative?  Yes.  Meaningful?  Yes.  Poised to take advantage of being in the right place at the right time?  I hope so.

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Bank of Dave boosts appeal of peer to business lending

a bank renamed with a sign reading "The Alternative"

Just after Bank of Dave was shown on Channel 4, I wrote this post about how the seeds of change were starting to sweep across the financial services industry.

Since then, the momentum has gathered.  Today the Daily Telegraph reported the results of a survey carried out on behalf of Myvouchercodes.co.uk  in which more than half of those surveyed said that they would switch to the “Bank of Dave”.

So, it seems like the public appetite for alternative finance is more than just a flash in the pan.  It seems like commonsense banking – the type that we’re interested in delivering here at FundingKnight – has really captured the imagination of the masses.

Of those who said they’d bank with Dave, 64% were attracted by the better rates of savings interest available.  That’s hardly surprising.  As I wrote in my last post – peer to business lending… more than just a romantic notion – trying to pretend that peer to business lending is not about competitive rates – for both borrowers and savers – would be naive.  Of course people want to manage their money well… but there were also large groups of people attracted by more social concerns.

57% liked the fact that Dave’s profits were headed straight for charity, whilst 41% mentioned the lack of bonuses for bosses as the reason they’d get involved.

Now, of course, FundingKnight is not a charity.  We are, however, committed to providing an alternative to bank based lending and borrowing.  We can’t promise a silver bullet to solve the world’s problems, but we do think that lending person to person, peer to peer can help make the financial world a little bit better for us all.

If the idea of better savings rates appeals to you, or you are a small business looking for a business loan why not register on the FundingKnight site.  We’ll keep you in touch with developments as we build a brand to shake up the way people lend and borrow money and we hope you’ll join us as we help small, independent businesses access the funds they need to grow.

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