Online lending has been having its Uber moment.
“Platforms spend as much as they physically can to dominate, with VCs behind them pushing for that growth. But now, a lot of VCs have left. Platforms will have to go out for funding again, and we’ll see massive down rounds,” says one platform founder, speaking on condition of anonymity. According to analysis from PitchBook Data, VC investment in the sector peaked in 2015, with $5.2bn (£4.3bn) invested across 132 deals. This year has only seen $2.2bn (£1.8bn) invested across 65 deals.
“If you’ve got to keep raising more cash just to stay alive, there’s a fundamental problem. Any business needs to, at some point, prove it can be profitable,” says the founder. And UK platforms, the majority of which have not seen consistent profitability, will have to go for more funding – because profitability means achieving massive scale, which requires a lot of capital.
Of course, you’ll find the same story in a lot of sexy tech firms: provided growth satisfies investors and helps customers, the party never ends. But as time goes on, the question of profitability will loom larger for online lenders.
So what will push them into the black?
For starters, there’s ensuring strong deal flow, while keeping the quality of the lender consistent. An unspoken truth in the industry is that it’s yet to get buy-in from two enormous investor cohorts that are critical to mass scale: on the retail side, the pensions and savings markets via IFAs and wealth managers and, on the institutional front, managers of conventional credit and fixed income funds.
“The reason for this is that platforms need to adopt standards of disclosure that encourage thorough and effective due diligence,” says Rupert Taylor, co-founder of AltFi.
Part of Taylor’s business is building this offering, but he raises an important point: as it stands, although you can usually access a platform’s full loanbook, these are often too big for Excel and impenetrable to all but the most patient expert. And it is static loanbook disclosure, meaning you’d need to piece together months of activity to get a picture of performance.
Moreover, although the P2P Finance Association provides standard definitions for members, these do not amount to standard metrics – methodologies can still be different. “Our answer is that they need to adopt a methodology that delivers an independently validated output that is consumable, comparable and credible. That’s how they’ll achieve far greater scale, and how they’ll become profitable,” says Taylor.
As Christian Faes, chief executive of online property lender LendInvest, says: “lending figures are just one metric. If I was an investor, I would want to know that the platform I’m trusting my money to is going to be around in one, five, 10 years’ time. We could all lend more if we wanted to, but it’s about lending sensibly.”
Skin in the game?
Another often-asked question is how important skin in the game is: will platforms attract more investors if they invest capital alongside them? Taylor isn’t convinced.
“It sounds attractive, but it’s actually a fraught process. The idea is to create economic alignment between platform and lender. But how much capital, and whose? Really, it should be the founders or the guy making the credit decision. Imagine policing that?”
Others consider this a false dichotomy. As Perry Rahbar, chief executive of dv01, told me earlier this year: “most platforms are levered towards performance already, since they don’t have permanent or termed capital. That means that if you do anything poorly or your loans don’t perform, there won’t be a bid for your loans.” In short, investors will vote with their feet. Which brings us back to the disclosure question. “If platforms want to see profitability, they need to get real with disclosure,” says Taylor.
Lending figures are just one metric. If I was an investor, I would want to know that the platform I’m trusting my money to is going to be around in one, five, 10 years’ time
Making money out of alternative lending also means doing it at massive scale. (Remember that platforms need to return some margin to lenders and themselves.) One way to get there more quickly is to take on some risk – because then you can take more return. Some platforms have got round this by acting as principal lender (i.e. putting up their own capital first) and keeping a chunk of returns, rather than originating and taking a fee.
For most people, the point isn’t going to be which model platforms move towards, but that investors and borrowers are clear on what’s going on. Again, it’s transparency that ensures they don’t get a shoddy deal.
The right partnerships
Another development for some platforms has been increasing origination partnerships to ensure recurring revenues. Banks don’t have the same issue with repeat custom – your customers use you for a range of services, not just getting a loan.
And neither do niche platforms – think Borro, which lends against luxury assets and property.
For online lenders, there can be more of a challenge: “either platforms spread their nets wider and acquire more customers – which is what they’re arguably trying to do – or they’ll have to charge people more,” says the founder. “The alternative is ending up looking like credit card companies, but with thinner margins.”
Providing a good example of what can be done is Zopa. Earlier this month, the platform announced its partnership with Airbnb, which enables customers to borrow for home improvements and to become Airbnb hosts via their Zopa dashboards.
Earn £500 from Airbnb within six months, and you get £50 knocked off your loan; £1,000 and it’s £100. The platform has also partnered with money management apps, and with Uber to give lower rates on secured vehicle loans.
Scaling up on the origination side will encourage more lenders and bring down the cost of capital, says Taylor. “It’s a chicken and egg situation. If you attract more capital to the asset class, you bring down the cost of funding you’re able to offer – and that’ll attract more origination.”
More institutional cash
Alongside wider origination opportunities, making inroads into an increasingly diverse funding base is vital for platforms. The 2015 Judge Business School and Nesta benchmark report on the alternative finance industry showed institutional involvement across 45 per cent of platforms, from 28 per cent in 2014.
Faes explains his approach: “for us, having multiple funding lines is a crucial part of us being a sustainable business.” Earlier this year, LendInvest secured a £40m dedicated funding line from Macquarie.
While some lament the rise of institutional funding – it’s flighty capital; it’ll invariably mean the pushing out of the retail investor – Faes says the combination of institutional cash and an online platform is simply how he can give investors and borrowers access to products.
“It means people aren’t quite sure what to call us – alternative, marketplace, online lending. But the point is that our industry has used technology to create a new asset class and give the man on the street access to it. Widening funding sources is a key part of being able to continue doing that.”
Taylor says he’s more than confident that the UK’s largest lenders will continue to do well and become profitable.
“As long as platforms can demonstrate that they can access new investor cohorts, then providers of equity capital will continue to see value in the model because, at scale, the potential returns to backers will be huge.”
As an industry insider puts it: “It’s just that some are about to have a tough time. Lending money is easy. But lending hundreds of millions when you’re losing money is just stupid. Doing it in a sound and sedate way, with rigid processes, is far harder – but it’s not impossible.”
This article appears in the upcoming edition of Money magazine, which will be distributed for free with the paper on Thursday 27 October.