Growth Street offers an overdraft alternative, like a line of credit available in the US, facility where one can draw and repay whenever they want. Such a facility allows for higher customer life time value and therefore can accommodate higher cost of customer acquisition. However managing lending capital cost and availability and the ongoing customer underwriting are more challenging.
Unlike in the US, in the UK businesses use overdraft to finance they short-term cash flows. However, overdrafts for small firms are being withdrawn or reduced by the high street banks at an alarming rate, restricting working capital for hundreds of thousands of British businesses.
Banks are reluctant to do overdraft because of the minimum capital requirement regulation by BASEL 3. If more than half of the overdraft is used by a business, it cost banks twice as much because of the additional capital buffer required. Another factor is information used by banks to give loans or overdraft is little outdated, as they use historic business data whereas Growth Street uses information via an integrated API, which is live and precise.
Around 17% of the UK’s small-to-medium-sized enterprises (SME’s) have reported that their overdrafts have been removed altogether and a total of 30% have seen reductions imposed over the past two years, according to a survey of 250 business owners by Bank of England. Data from them showed that £5m-worth of SME overdrafts have been cut every day since 2011, as banks seek to reduce the risk on their balance sheets.
Origin of Growth Capital
Shortage of working capital for small businesses was the driving force behind the genesis of Growth Street. The start-up is headquartered in London and is a business to business marketplace for alternative overdrafts. It was established in 2013 by five like-minded people looking to disrupt the short-term financing market. In their first round of investment, they were able to raise $7.6 million from Art Alliance Ventures and David Giampaolo and another $8 million was raised in last quarter of 2015. Joshua Green, chairman of the group is a successful investor and thus brings in a lot of experience. James Sherwin-Smith is the CEO of the group and describes himself as an engineer by education, consultant by experience and entrepreneur at heart, and has been part of many successful startups like Dsruptiv, d4.
Overdraft vs term loan
The fixed term loan is a popular choice for small businesses, but they have to pay off the loan on a monthly basis which magnifies the problem for a growing business. Growth Street connects the businesses who want to lend with the businesses that want to borrow, they are like an exchange that matches orders. The originator seeks to obtain a continuous stream of information from the businesses both before the loan and after the loan, to make sure the borrowers get the required amount of limit and all the assumptions and calculations are appropriate. This day to day monitoring also helps them identify any future stress in their borrowers.
Growth street uses number of factors to check whether a business qualifies or not, following is the list below:
- Current and historic profit before tax.
- Current assets and current liabilities.
- The stability of the business (which they can establish by reviewing the net assets over time.)
If the borrower is approved, they can borrow from £1,000 to £500,000. Once they become a customer, they will review the status on a regular basis, and may be able to increase the facility limit and decrease the interest rate as the business grows. Growth Street generates their revenues from the interest they charge on the money they lend on behalf of the lenders. There is a monthly fee of 0.4% on the peak amount borrowed and there are no fees for any month in which they don’t borrow. Borrower’s interest rates vary on market conditions and business profile, but usually, they are from 0.2% to 1.25% per month. The representative APR is 11% at an assumed facility utilization rate of 70%.
Lending Capital Sources
Growth Street funds come from the group of high net worth individuals and private corporations, led by Art Alliance. In the near future, once they receive appropriate permissions from Financial Conduct Authority (FCA) they are planning to open up the marketplace for everyone who wants to become a lender. Currently, Growth Street has 25 well-trained employees in technical, sales and marketing, and legal department. They have an in-house risk process and underwriting team that does all the analysis and credit approvals. They have a provision fund which basically protects the lender from any defaults or losses.
Part of the payment goes to this provision funds and is also protected by mezzanine debt. Lenders place the offers on the platform; they have the provision of either place the bid at market rate or whatever specific rate they want. Lenders get full payment at the end of the tenure and they can decide to lend the money again through the marketplace or withdraw.
After assessing the borrower’s profile, borrowers and lenders are matched for 30 days. If the borrower is able to pay before 30 days, a new order is created and is matched with a new lender at a new price, the lender offering the cheapest rate is matched. It is a reverse auction for lenders, each lender will bid an interest rate, and the cheapest rate gets matched first. Typical range borrowers are willing to pay is 8-15%, based on variable risk rate.
The company’s current book stands at “multi-million pounds”, with the target to achieve triple figure million pounds. They are simultaneously also looking for international opportunities.
Research analysis of 160,000, Companies House records showed that UK SME’s, unable to access capital from the banks, are now using £76bn worth of alternative finance. Alternative lending to SME’s is now equivalent to 46% of the value of traditional term loans and overdrafts, which have fallen to £163bn, down 5% from £172bn a year ago, and 17% from £197bn four years ago. If these numbers are anything to go by, Growth Street has a good chance of beating the high street. The Brexit provides another opportunity for the alternative lender to capture the market being exited by continental banks in London.
Author: George Popescu and Heena Dhir