TAEFL specialist partners ArchOver in funding SMEs
ArchOver Chairman Brian Basham (left) with CEO Angus Dent in promotional mode
Regular readers of the TAEFL newsletter will have noticed an increasing number of references to clients who have raised funds through a peer-to-peer (P2P) lending platform. In the press as a whole, discussion of crowdfunding has moved from single paragraphs in the business sections to features on the news pages where they command a wider audience.
For the lender, crowdfunding is an opportunity to increase the yield on surplus funds. While there is inevitably a lower risk with a 5 year bond in a building society, lending through a well-managed crowdfunding site provides a way of generating an additional income at an acceptable level of risk.
On the opposite side of a P2P deal, the businesses taking advantage of the arrangement are able to access funds which would not be readily available to them from traditional lenders.
Most P2P crowdfunding employs auction platforms which set out to match the supply of loans with the demand for debt funding. As in any other auction, the price of the commodity reflects a balance between the rates which borrowers are prepared to pay for funds and the level of interest which lenders feel is appropriate to the perceived risk involved.
The longest-established platforms have had at least one failure; some more expensive to lenders than others. As a result, lenders are now taking a belt-and-braces approach, demanding higher interest rates and security comparable with that taken by the high street banks in the days when they were in the business of lending. Personal guarantees from directors are now the very minimum security required by lenders.
There is a school of thought which maintains that personal guarantees are unnecessary; employed as a substitute for thorough due diligence. The lender should check the deal properly. Either the borrower company can afford the borrowing in all senses, or they cannot – in which case no loan should be made to that company. Putting a director’s house on the line does not resolve the issue: it probably makes it worse.
P2P platforms have been evolving to reflect that changing business environment. One crowdfunder, ArchOver, entered the arena as recently as 2014. It has brought to the table a distinctive solution which overcomes resistance to the risk surrounding borrowers.
The company and its business model are worth examining more closely as the platform has proved an important source of funds for UK EXIM Finance Ltd to apply in financing its own clients’ orders. This particular company is a specialist lender within the Trade & Export Finance organisation.
The group of entrepreneurs who conceived ArchOver in the summer of 2012 set out to rationalise funding for SMEs. The team all had direct experience in analysing and managing SME and start-up ventures of varying sizes and complexity. CEO Angus Dent, for example, had headed an AIM listed company and had seen first hand the problems faced in the marketplace. “The cost of raising funds – particularly for financial reporting and due diligence – is too high when raising the £200,000 to £500,000 which many well-run businesses might be looking for to fund their development.”
Eliminating the auction process
What is the distinctive solution which differentiates ArchOver from other lending platforms? Potential lenders assess a proposition on the platform, then commit to funding a part of it. But there is no price-determining auction, as Mr Dent explained. “We felt it was important to keep the funding process as simple as possible as that ensures both transparency and trust.”
Examination of an ArchOver contract shows that the deal relies on the quality of the borrower’s Accounts Receivable ledger. “We insist on a credit insurance ‘wrapper’ to ensure that those receivables will materialise and are able to pay off the loan. With that cover in place, we do not need to seek personal guarantees from directors to secure the debt. Borrowers can therefore concentrate on what they do well.”
It transpires that the credit insurance is not an off-the-shelf policy but the result of an innovative arrangement. A computer-based risk analysis process simplifies the application process and allows ArchOver to determine cost-effectively whether the loan should proceed without its having to run its own time-consuming analysis.
And if the computer said “yes” when it should have said “no”? Angus Dent identified the single feature which had turned the original good idea into a rock solid proposition. “The insurer was prepared to cover its rating of each deal so we had the certainty of being paid in the event of a loss. That was the defining moment, which changed completely the risk profile of the venture.”
Ensuring that the value of receivables always exceeds the outstanding debt by an acceptable margin is essential. ArchOver has ‘tweaked’ the insurance policy to pay out in its favour should a claim become necessary. The company determines whether the cash goes back to the lender to keep its loan-to-value ratio constant: if there is a surplus at that stage, it can be repaid to the borrower.
Fixed interest loans
The ArchOver solution has implications for the lending process. One is that the company has established the fixed interest rate at which loans are made rather than leaving this to the vagaries of sentiment in an auction. Angus Dent explained why it is possible to charge all borrowers the same fixed rate. “With credit insurance, we have taken away the main reason why borrowers do not repay their debts – 80% of the risk is that their customers do not pay them.
“The insurance cover on the receivables means that we have homogenised the level of risk across our loan book: all loans effectively carry the same risk and therefore justify the same interest rate. Having eliminated the variables, we were able to set that rate a year ago. Nothing has changed our view. The rate is positioned where SME borrowers can afford the loan and the solution works well for both sides, as we pass the majority of that interest on to the lender.”
In the event of a rise in UK base rates over the coming year, it is understood that ArchOver would attempt to keep rates at their present level as long as possible while monitoring the margin between the rate charged to lenders and the rates available on ‘risk-free’ deposits in the marketplace.
Different profile of lenders
Moving away from the free-for-all auction environment to a fixed interest model might well see a different type of lender attracted to ArchOver. The company’s CEO accepted that it had a larger institutional base than other platforms, led by the Hampden Group which had provided the initial source of funds and is currently the second largest lender. “Everyone on our platform receives the same terms, so our individual lenders can draw comfort from the fact that they are following the professionals.
“It means that the breakdown of the lenders is likely to vary from loan to loan. Some of the deals in the summer of 2015, for example, were filled entirely with individual lenders’ money – that is probably a seasonal factor. But we have also had a situation where the whole of a loan was taken up by just two institutions: as crowdfunders, we would probably not see this as a ‘crowd’.”
From researching the ArchOver model in the summer of 2012 to its launch took almost two years: the first loan was made a short time later in September 2014. The company has achieved its objective of providing working capital to help SME ventures grow. Two of the first borrowers on the platform have fulfilled their commitment and are seeking additional working capital to finance their next phase of expansion.
Complementary role of UK EXIM Finance
ArchOver has established a successful relationship with UK EXIM Finance. Funds borrowed by that company are lent out to SMEs to help fund orders. Would it not be more cost-effective for the borrowers to approach ArchOver directly?
Angus Dent sees a particular role for UK EXIM Finance in the funding process. “What Mark Runiewicz and his team do is very specialised. They work at a ‘granular’ level that we are not geared up to do, but they go about it in a way that is secured and insured, and is therefore within our model. Bills of Exchange from their clients are assigned to ArchOver, and we have a charge over them. UK EXIM Finance has a wholesale credit insurance policy which they use to cover all their clients.
“They are complementary to what we do, lending relatively small amounts typically for 90 days, while their clients’ deals are completed. Our loans are usually upwards from £150,000 and for fixed terms of 6 to 36 months. The two models fit comfortably into the same framework. UK EXIM Finance demonstrates the flexibility of our approach.”
Are enough lenders available for ArchOver to continue?
ArchOver may only have been lending since September 2014, but its deal flow is strong; lenders and borrowers attracted in equal measures by the business model. According to Angus Dent, every deal taken on board has been funded successfully. As the company expands the volume of loans made through its platform, that might not always be the case.
Does ArchOver have any plans for raising equity capital; no doubt applying the accumulated skill set of its management in this field? It is a route that Angus Dent does not rule out: there are untapped pools of funds such as Self-Invested Personal Pensions (SIPPS), which the company might consider addressing in the future.
ArchOver is sufficiently different from the mainstream of crowdfunded lending to have created an entirely new route to funding business growth. Through its relationship with ArchOver, UK EXIM Finance is able to roll that innovation out to a smaller business community frequently held back from realising its full potential.