JournalOct 2014

A short adventure in crowdfunding. And why we turned the money down.

I’ve been looking out for potential finance options for Hanno for a while. The one thing in common has been that all the offerings from our bank (HSBC) are distinctly unappealing.

A stated maximum of £25,000 available “from 5.9% AIR (Annual Interest Rate) set on the basis of our assessment of your financial status”.

On top of that, you need to go through a slow and cumbersome application process–for us, this is really where the issue lies. I looked into a few options and one of the most interesting was Funding Circle, which is a UK operator with ties to a few government backed schemes. Indeed, on the loan application we put in, the final 10% of the loan value was met by the British Business Bank programme.

Since I couldn’t find a vast amount of information online about how the experience might be for loan applicants, I’m sharing our experience and thoughts on the process from an almost-borrower’s perspective.

Auction overview page

The key details

  • We applied for a £75,000, 2 year loan.
  • They suggested that we reduce this to £50,000 to maximise our chances of getting funding.
  • The application process itself took 10 days before the loan was listed because of some issues on their website (now fixed).
  • It took a further 2.5 days to fully fund after the application was submitted. At that point, the interest rate was at 13.1%.
  • Over the next few days, Funding Circle’s auction process gradually reduced the loan cost down to a closing rate of 10.81%, a week after the loan first entered their marketplace.
  • Ultimately, we decided to turn down the loan as we secured funding on better terms from elsewhere.

Making the application

The application process was relatively smooth, even if it took an extra couple of days to complete due to the bug in their signup process which stalled things entirely. I was quite surprised at this actually–it’s rare to hit such huge blockers these days, particularly on such a crucial part of a new customer’s onboarding process. Perhaps they need to extend their test coverage to make sure that this sort of thing gets flagged-up a lot sooner.

Once that hurdle had been overcome, things were pretty smooth. A few additional documents were needed, including our business accounts, but everything was straightforward.

One thing did catch me by surprise though–when submitting the application, I mentioned to my account handler that I was expecting to get a little extra guidance on how the process would work, and the sort of interest rate that I’d be likely to receive before confirming the loan onto the marketplace. So I was caught a little off-guard when he replied with the following:

"Hi Jon,

We have the offer in place now, so I wanted to get back in touch to go over the next steps. I appreciate that this is less than you originally wanted to receive, and the offer was reduced due to the young age of the company and the loan amount/turnover fraction.

However, now that the offer has been made, your funds are definitely in place at a rate of ~12%. The next step is to put the application forward to our investors and get them to bid their interest rates to be part of your loan.

The process takes between 2-7 days and at the end of it you will be able to view a final contract with the final terms and conditions, and you’ll have 7 days to accept.

I’m pushing everything to the investors now, but please let me know if you have any questions."

Since the early stages of the application are very much “plug in your details, and we’ll let you know how much you could receive”, I was surprised that I wasn’t given a chance to confirm before the application went public. I can only assume that from Funding Circle’s perspective, they’re not too worried about applicants declining the loans, and their main goal is to get decent investment options onto their marketplace and hope that their user base offers an enticing enough interest rate for them to be convinced to accept the offer.

How the marketplace and loan rates work

One page I didn’t spot prior to filing our application (it feels like it’s somewhat hard to find for loan applicants) was their helpful statistics page – it’s definitely worth a look because it seems to give a much better indication of the likely interest rate than the price calculator on their main site.

Here, you can see the interest rates over the last 100 loans they’ve made. There’s a strong correlation between the risk banding assigned and the interest rates available:

FundingCircle marketplace statistics and loan rates

A strangely ‘shy’ website

Oddly, I found the Funding Circle site to be a bit opaque at times, given how transparent crowdfunding sites typically are. It’s somewhat difficult to figure out how to view their full marketplace before signup, whereas the whole thing is publicly visible if you know the right URL. And being able to see the marketplace gives you a much better feel for the funding you’re likely to get than looking at their loan price calculator.

Let’s take a look at the rates on offer when you’re signing up:

The loan value slider mechanism

The important part here of course is the bit at the bottom: “Quick quote is indicative and intended as a guide only. Based on average rate of A+ risk band business loan”. Now of course you’d expect that, since it’s a quick, automated tool, and they need to plug in a little javascript to be able to give a pricing indication.

But even so, basing that calculation on the average rate for A+ businesses seems a little bit misleading given that at the time of writing (22nd September 2014), there are 16 A+ loans available on their marketplace of a total 65 loans available. That’s about 25% of the marketplace volume. It would have been much more representative if they’d used the A or B band average loan values as a guide or even added a link to their stats page.

The marketplace at the time of writing

Slightly risk-averse underwriters

Given that the Funding Circle risk assessment bands run from A+ to C-, I was actually quite surprised that we were given a C banding.

Of course it’s their prerogative to set the band classification at whichever level they feel protects their investors best and matches the profile of the marketplace they want to build. I understand the rationale. From their perspective, we:

  • Are a relatively young company (incorporated 2.5 years ago).
  • Have a low value of physical assets (because we’re a digital services business).
  • Although we’re comfortably profitable now, we’re still a growing-business and our loan value was statistically quite high in proportion to our last full year of annual accounts (filed 8 months ago).

Nevertheless, it was surprising. From what I know, we have a strong credit health (of 97/100) and the business has always been profitable and entirely self-funded. We’ve made it through our first 2 years smoothly and are now starting to see the benefits of having a more established team, brand, and client base. Still, it’s useful to get this sort of insight into how others evaluate your financial position as a business.

From a client’s perspective, it was surprising that there wasn’t a little extra upfront transparency on their criteria for loan banding, given how strong an impact it appears to have on the loan rates.

How does it work

Once the application reaches the marketplace, it goes through a Kickstarter-style funding process until you reach your funding target—£50k, in our case.

But the difference with Funding Circle is that once you reach your funding goal, the process continues and the ‘auction’ element comes into play. This means that when we were first funded, our interest rate was much higher than the closing 10.81% we ended up with.

It’s a smart way to handle things and it seems to maximize your chance of getting funded. We closed the week at a much lower APR.

So why did we turn it down?

The interesting thing about the process was that it made it much easier to secure funding elsewhere. With the auction in place and investors willing to lend us the amount we’d asked for, it sets an attractive benchmark that we could take to other investors for private funding.

Now, had we taken the funding, I would have been required to put down a personal guarantee. However, the funding itself would have come with very flexible terms, including no penalties for early repayment and us receiving the funds in our account within a couple of days.

On the whole, I was impressed with Funding Circle. The process moved incredibly faster than it would have done if we’d gone through a bank, and it opened up a good source of investment at a reasonable rate.

I think it could be a great service for many smaller businesses looking for funding, particularly those who have been running for 3 years or more. That makes it less of an option for new startups, but definitely something I’d consider myself if we were a bootstrapped startup looking to take a step up by raising a little funding.

It’s definitely something I’d investigate again if we were looking for funding in a year or two and able to access the better risk bandings for more favourable interest terms.

Posted by
Jon Lay

Jon is a Partner at Hanno. He wears many hats, but his primary focus is on leading our engineering and technical operations.