Funding Circle IPO: everything you need to know
Peer-to-peer lender and fintech firm Funding Circle has listed in London as part of it plans to accelerate its international expansion and steer the evolving regulatory journey that the industry finds itself on. We have a look at the Funding Circle IPO and how it has performed since listing.
Funding Circle, the fintech peer—to—peer (P2P) lending platform that matches businesses in need of cash with investors hungry for better returns, has joined the the London Stock Exchange (LSE), raising fresh capital to fund its international expansion, and to become more transparent amid an evolving regulatory landscape.
Funding Circle’s 80,000—strong community of individual investors plus local governments and other financial institutions have collectively lent out £5 billion to small and medium—sized businesses (SMEs) in its eight year lifespan — over £1 billion of which has been dished out since the start of this year.
The business has shown that demand for alternative sources of funding is ripe. Funding Circle’s revenue in the first half of this year was more than double the figure for 2015 as a whole and, with material earnings and progress being delivered by its home market in the UK, the company believes it is the right time to launch an initial public offering (IPO) to help build its position in the US, Germany and the Netherlands before expanding into new territories.
However, both the firm and others are sailing in relatively unknown waters, with regulators across the world still deciding how best to regulate what is still a relatively new market. US peers have fallen, the accounts are covered in red ink and their ability to handle an economic downturn is unproven — so, what does it all mean for Funding Circle and other P2P lenders?
Financial crash creates need for P2P lending
‘The financial crisis revealed important weaknesses in many areas of our financial system,’ — US Federal Reserve (Fed) Chair Jerome Powell, 21 November 2013.
The world is still feeling the effects of and learning the lessons of the financial crisis in 2008 ten years on. While many focus on the decade of stagnation and calculating how much worse off we all are as a result, the crash also prompted new innovation and encouraged different ways of thinking, which should be equally celebrated.
Traditional banks were in turmoil after the collapse of Lehman Brothers (the biggest corporate failure in history) rippled through the global financial system. Following years of banks exercising over—exuberant lending practices to businesses, many SMEs have found it harder to obtain the finance they need, while those investors looking to tuck their money away in savings have been offered rock—bottom returns driven by record—low interest rates.
Lending to SMEs has tightened because banks have reduced their appetite for risk, instead concentrating on larger businesses that have less chance of defaulting on their loans. Banks and other traditional lenders still remain the biggest source of finance for smaller businesses, but overall lending to SMEs has declined. In the UK, lending has fallen 13% from £189 billion in 2011 to £165 billion in 2017 and in the US the figure has dropped 10% from $781 billion in the middle of 2008 to $699 billion last year.
That, coupled with the development of technology, has provided a gap in the market that has borne the emergence of several alternative sources of finance. This has given consumers and businesses that have been forced to use the big traditional banks for years, despite having lost trust in them in the wake of the crash – including the likes of cryptocurrencies — other choices.
A slew of challenger banks have surfaced and become sizeable competitors, taking on what their larger peers have abandoned. Metro Bank was the first new high street bank to be launched in over a century when it opened its doors in 2010, Virgin Money has pioneered the online offering, and OneSavings Bank has found a niche in mortgage lending. Both Metro Bank and Virgin chase SME customers like Funding Circle, and all three have become major lenders.
Between March 2016 and March 2018, Metro Bank and Virgin Money had collectively loaned out almost £11 billion (net), more than Barclays, Lloyds Banking Group and Santander combined. Funding Circle is even more impressive: the value of the loans it made in the second half of 2017 outstripped that of the entire UK banking system.
Funding Circle states that every £1 loaned out through its platform supports £2 of additional gross domestic product (GDP), demonstrating the effect of its alternative funding. The business supported £3.9 billion worth of additional GDP across all four of its markets last year, generating £1.3 billion of tax receipts and facilitating 75,000 jobs.
What business model do P2P lenders use?
‘By combining cutting—edge technology with our own proprietary credit models and sophisticated data analytics, we deliver a better deal for small businesses and investors around the world,’ — Samir Desai, chief executive and co—founder of Funding Circle.
P2P lenders have different ways of carrying out their business but the principle remains the same. They act as intermediaries that connect those wanting to borrow money with those that want to loan theirs out to get a return.
Funding Circle acts as the middleman. It vets the SMEs that are looking to borrow money by carrying out credit assessments based on its own modelling in order to give the investors the confidence to loan out their funds to the borrower. It then facilitates the loan between the two parties, collecting the repayments from the borrower and the interest for the investor.
For its part, Funding Circle charges a transaction fee for every new loan deal struck on its platform — somewhere between 1% and 7% — and charges an annual servicing fee of 1% on the loans it has under its management.
For borrowers, the two main reasons they opt for Funding Circle is because of the ease and speed of the process – with potential for SMEs to access funds within hours of applying. A company survey reveals that 28% of its customers said the simple application was the main factor behind their decision to use Funding Circle, with 26% stating it was the speed. Other reasons (all below 10% each) included competitive interest rates, better terms and conditions, and because they either don’t trust banks or have been rejected by one. Still, Funding Circle claims 16% of its customers said they wouldn’t have been able to secure the finance they needed without the platform.
For investors, the offer on the table is higher returns than what other alternatives offer — like the rate on savings accounts and bonds, or opportunities in the equities markets, to name but a few. Funding Circle has offered investors returns between 4.4—7.2% since inception (5.5—6.5% in 2017), well ahead of the average 1% rate on UK savings accounts in 2017 (the lowest on record according to SwanlowPark). UK, Eurozone, Japanese and emerging market (EM) equities all returned roughly 9.5% per year over the three years to 2017, and that has been driven more by ever—higher valuations and dividends than it has been by earnings growth, particularly in the US and the UK.
Funding Circle does not guarantee liquidity or hold the value of the loans on its balance sheet. It is a secondary marketplace, meaning that the returns offered by the business comes at the cost of the investor having to take on more risk. However, the idea is that if Funding Circle does its job of ensuring it only connects viable SMEs that can afford to repay their loans with investors of equal quality, then this shouldn’t be an issue. But it also has to balance the amount of businesses and investors it has, ensuring it has enough finance for those that need it and enough SMEs to satisfy all the investors looking to deploy cash.
Facilitating trust between both parties, underpinned by its software, algorithms and data—modelling, is the core job at hand to ensure that no one, including the company itself, comes out worse as a result of using its platform.
What valuation will Funding Circle have after its IPO?
Funding Circle priced its IPO at 440p, the lower-end of its targeted range of 420p, and £5.30, giving it a valuation of around £1.5 billion upon listing. The company raised £300 million and had a free float of over 29%.
However, its share price has faltered since. On the first day of trading Funding Circle shares opened at 460p but have since collapsed to as low as 340p. Whatever the cause, Funding Circle seems to have significantly overpriced its IPO.
Funding Circle shareholders: who owns the P2P lender?
In addition to the fresh capital raised as part of Funding Circle’s IPO, existing investors sold a further £141 million worth of shares, considerably lower than first anticipated.
Funding Circle raised £250 million in equity from six rounds of fundraising between March 2011 and May 2017, with more raised before it launched its IPO.
Funding Circle: cash flow performance since 2015
|(£, millions)||2015||2016||2017||H1 ‘17||H1’18|
|Net operating cash flow||(35.4)||(40)||(22.6)||(17.2)||(16.8)|
|Net investing cash flow||(10.1)||(6.1)||(12.7)||(3.9)||(7.4)|
|Net financing cash flow||95.1||0||81.9||81.9||0.2|
|Net cash flow||49.6||(46.1)||46.6||60.8||(24)|
|Free cash flow||(45.5)||(46.1)||(35.5)||(21.1)||(24.2)|
|Cash balance at period—end||86.3||43.3||88.9||103.5||65.2|
While it has continued to burn through cash, the company’s losses have shrunk over the years and it has secured significant backing from institutional investors throughout its funding rounds. It now boasts major shareholders including Baillie Gifford, DST Global, Index Ventures, Rocket Internet and Temasek Holdings – some of the firms backing big tech firms like Twitter and Facebook.
In what will be viewed as another big call of support for Funding Circle, Danish billionaire Anders Holch Povlsen has agreed to take a 10% share in the business through his holding firm Heartland A/S as part of getting the IPO up to a maximum valuation of the business at £1.65 billion – supporting the reported valuation ranges so far. Povlsen currently holds investments in the likes of online fashion retailer ASOS and German rival Zalando, and is reported to be one of the biggest landowners in Britain.
When is the Funding Circle IPO likely to happen?
Funding Circle listed in London on Friday 28 September 2018. The company had long been in the reported pipeline of IPOs that were expected. Following a fundraising in early 2017 the company earnt its ‘unicorn’ status – those companies that could float with an initial value of over $1 billion – and estimates were as high as £2 billion earlier this year.
Why did Funding Circle launch an IPO?
Funding Circle launched an IPO to shore up its balance sheet and provide the capital it needed to continue expanding in the US, Germany and the Netherlands, including the money it needs to continue investing in technology and systems as well as its marketing efforts to raise the profile of its brand.
In addition to facilitating deals Funding Circle’s other big job is to attract new borrowers and investors to maintain growth and to ensure it can provide for both ends of the scale. Marketing is already a major expense for the business – falling from 69% of revenue in 2015 to 39% in the first half of 2018 – and nearly one-quarter of its staff is marketing based.
Its marketing strategy seems to be working so far. Revenue growth has far outpaced that of the cost of advertising and the amount of new borrowers it has secured itself has continued to rise, from 70% in 2017 to 72% in the first half of this year, meaning it is slowly becoming less reliant on third party leads which are far more costly to acquire than direct ones. Still, a significant amount of new business comes from other companies.
Funding Circle believed its IPO is an important step to becoming more transparent, opening itself up to public scrutiny in the hope of installing trust with customers and regulators alike. Although the regulatory landscape for P2P and other similar forms of lending is yet to be moulded, it is more a case of the industry moving with the evolution of new legislation (which is definitely on the horizon) rather than facing pressure over the way it operates. In fact, the mood has been supportive as governments are keen for businesses and consumers not to be so reliant on big banks in case another crash occurs. Major institutions like the British Business Bank and the European Investment Bank have lent public money to SMEs through Funding Circle’s platform, showing its job at connecting funds to the businesses that need it is working. Still, regulatory risk is at the top of Funding Circle’s list of concerns moving forward.
Funding Circle: revenue driven by new loans, margins by repeat business
The firm has seen revenue grow dramatically over the past three and a half years, driven by the cut it takes from each new loan deal made on its platform. This means that maintaining growth is all—important for revenue as the amount it makes from servicing the loans is small and restrained by limited growth.
Annual growth in loans under management has remained steady but in decline, growing 52% year—on—year (YoY) in the first half of 2018 compared to 58% for full—year 2016. It is a similar picture for growth in the value of new loans (growing 47% in 2016, 63% in 2017 and then 31% in the first half of 2018). The volume of loans grew 43% in 2016, 70% in 2017 and 37% in the recent six—month period.
Funding Circle: KPIs since 2015
|(£, millions unless stated)||2015||2016||2017||H1 '17||H1'18|
|Loans under management||860||1362||2107||1705||2584|
|Number of loans originated||9568||13,724||23,350||10,734||14,783|
|Marketing spend as % revenue||64%||49%||41%||38%||39%|
Growing both the volume and value of its loans is important for Funding Circle. The average business borrowing through the company has an annual revenue just shy of £1 million per annum, with eight employees. From a range of £5000—£1 million the average value of each loan is about £70,000, with a rate varying from 1.9% to as high as 27%, with the average sat at 11%. Borrowers tend to repay their debt within 52 months, at the back end of the six to 60 month range.
One important element to Funding Circle’s model is repeat business. The company claims nearly nine in every ten of its customers, should they need funding again, would use the platform first before heading to the bank. Existing borrowers accounted for just under one—third of all new loans made through Funding Circle last year, and it has also been seeing a solid retention of investors that are willing to redeploy their capital once existing loans made through the platform have been repaid. Combined, this suggests that both borrowers and investors have remained satisfied with the rates they have been able to secure through Funding Circle. Still, while securing long—term borrowers and investors has several benefits, it shouldn’t retract from the importance of securing new ones.
Margins are higher for repeat business, as the company doesn’t have to spend cash to secure their custom. Its margin on new, first—time loans last year was 20%, up from just 1% in 2016 and —37% in 2015 whereas repeat loans have delivered margins of 37%, 40% and 23% over the same period, respectively. Those that continue to use Funding Circle also tend to leave a balance in their account, making them part of the company’s long—term capital structure over time.
How has Funding Circle performed financially?
While revenue has grown at impressive rates, Funding Circle has remained firmly in the red since inception. Losses have shrunk, but they are still fluctuating as it continues to invest in its technology and ramp up the business. At an adjusted earnings level, its UK business has been moving into increasingly positive territory for the past 30 months or so, while the losses spawning from its newer businesses in the US, Germany and the Netherlands have continued to narrow
Funding Circle: financial performance since 2015
|(£, millions)||2015||2016||2017||H1 '17||H1 '18|
|Germany and Netherlands||(1)||(9.1)||(9.9)||(5.2)||(3.8)|
|Adjusted EBITDA margin||—69%||—52%||—4%||—7%||1%|
|Germany and Netherlands||—200%||—650%||—261%||—578%||—73%|
|Diluted loss per share||(17.4p)||(15.6p)||(14.8p)||(8.1p)||(10.3p)|
Considering Funding Circle’s business has been founded on the growth and progress made in its home market, it is a positive sign that all three of its businesses in the US, Germany and the Netherlands are growing at a faster rate than the UK business evolved. That will also give it encouragement to enter more territories.
What market share does Funding Circle hold?
Despite its market—leading position in the P2P space, in all of its markets the company’s share of the overall lending to SMEs is tiny, even in its core UK market. The £1.26 billion of new loans made through Funding Circle in the UK last year was just a drop in the total pool of £35 billion, and its loans under management at the end of last year represented just 1.9% of the total addressable market of £85 billion. However, this also demonstrates the vast opportunity that Funding Circle is chasing. Its share of the total addressable market in the US and the Netherlands is at 0.2%, and in Germany it stands at just 0.04%.
How is Funding Circle performing in its core UK market?
Funding Circle has built the foundations well as a springboard for international expansion through its UK business, which has facilitated £3.8 billion worth of loans to 39,000 UK SMEs. While its reliance on the UK in terms of the value of the loans under management will wane as other markets evolve, it still currently accounts for over 70% of its total loan portfolio.
Funding Circle has had the right environment to thrive but it has also had a lot of competition from other firms (like challenger banks) that are also seeking to reap reward from the retreat of the big banks from SME lending. Although, the seven largest banks in the UK — Barclays, HSBC, Santander, Royal Bank of Scotland Group (RBS), Lloyds Banking Group, Santander and Nationwide — still account for nearly two—thirds of all loans made to SMEs in the UK.
Funding Circle: regulation in the UK
The regulatory environment may have encouraged Funding Circle in the UK thus far, but change is on its way. The business set itself up as a self—regulated entity and the legal framework in the UK and elsewhere is still in its early stages, with the likes of P2P lenders being squeezed into existing laws governing their types of business.
The UK Financial Conduct Authority (FCA) launched a review of crowdfunding in 2016 and published proposals earlier this year that it has sought responses to. The focus has been particularly on how new lenders like Funding Circle protect investors deploying their capital, and whether more measures need to be introduced. The current proposals would uphold lenders to ensure that they collect adequate data to make worthwhile credit assessments, regulate some marketing activity and, most importantly, introduce ‘wind—down’ plans to provide a fail—safe should they fall like the bigger banks have done in the past. Additionally, the Treasury Committee has opened an inquiry into the state of SME finance, the outcomes of which could form part of any forthcoming changes to regulation.
While the FCA’s proposals are tentative at present, new laws are likely to be introduced sometime next year and some are wary. The FCA has stated that there ‘appeared to be increased pooling of credit risk for investors’ which had the ‘potential to create a blurred line’ between loan—based crowdfunding and asset management, and that some also have ‘similarities to banking operations’. If the FCA deems that Funding Circle needs authorisation to conduct asset management or banking activities, then that would upheave its entire business model, with the latter proving particularly detrimental. This could require it to hold part or all of the loans made on its balance sheet for example, and pay the huge sums needed to secure new licenses to stay in operation.
How is Funding Circle performing in the US?
Funding Circle entered the US in late 2013 via its acquisition of an established lender named Endurance Lending Network, giving it a base for its first overseas expansion. It also used mergers and acquisition (M&A) for its European expansion, making further M&A of foreign lenders likely as it moves into new territories.
The potential of the US market is obviously far greater for Funding Circle, but the need for scale, the regulatory risks and level of competition are all greater. SME banking is much more fragmented in the US, partly thanks to laws varying state—by—state. Still, loans through the platform were 12 times greater than reported in 2015 and the US now accounts for well over one—fifth of its loan portfolio, offering SME loans in all but one state, Nevada.
Funding Circle: regulation in the US
Funding Circle has admitted that its business has ‘not entirely been tested yet’ on a regulatory front, and has warned its operational flexibility and speed of growth could be hindered depending on the outcome of what looks to be inevitable regulatory change.
The business is waiting to find out the outcomes of a white paper published by the US Treasury in 2016 proposing a bespoke, limited ‘Fintech Charter’ to allow firms like Funding Circle to provide banking activities. One possible change could be the requirement to hold some of the liquidity on its balance sheet for a limited time. Additionally, the national organisation for state financial regulators has proposed standardising and converging certain aspects of the industry, which could change how the industry has to operate in the future.
US P2P lenders cast dark cloud over Funding Circle’s prospects
Doubts over Funding Circle’s future in the US have been cast by the flops of similar businesses in the US, such as LendingClub, On Deck, and Prosper Marketplace.
Lending Club floated in 2014 with a valuation of $5.4 billion and is now worth just $1.4 billion following a corporate governance scandal that has pushed up legal costs and sparked several resignations.
Meanwhile, half of Prosper Marketplace’s loss last year was down to the cost of offering incentives to entice new customers – something Funding Circle does, using the likes of cashback as form of marketing. This stresses the need to keep maintaining growth because, without new loans driving transactional revenue, the business would grind to a halt and push up marketing costs in the desperate need for more business. This same problem has also partly driven the decline in OnDeck shares, having seen their collective value plunge to just $577 million compared to $1.3 billion upon listing in late 2014.
Funding Circle in Germany and the Netherlands
Funding Circle entered its two newest markets in late 2015 and it is still early days, but the fact that growth is outpacing what it managed to deliver in the UK provides confidence in its prospects.
While Funding Circle replicates the same model it used in the UK in its other locations, each market is significantly different. The top five banks in the Netherlands account for 85% of lending to SMEs, whereas in Germany it is dominated by co—operative, state and savings banks.
Funding Circle IPO
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Funding Circle: regulation in Germany and the Netherlands
The regulatory picture is as unclear in these two markets as it is elsewhere, with ‘no other statutory bespoke crowdlending regime in Germany’ apart from guidance issued by regulator BaFin, and ‘no bespoke domestic regulatory regime’ for platforms like Funding Circle in place for SME lending in the Netherlands.
The firm has cautioned that the chosen regulator for P2P and similar lenders in Germany is still up in the air, warning that it could fall under the German banking laws, which would have a significant impact on the business due to the cost of acquiring new licenses. In the Netherlands, the regulator Autoriteit Financiële Markten (AFM) monitors the industry closely and has introduced measures such as an €80,000 cap on investors and a 48—hour cooling off period — limiting its ability to grow value and a hurdle for its speedy processes.
Still, the European Union (EU) will be at the forefront of future regulation in these markets and the importance of Brexit is heightened. The EU proposed regulating the industry in March, with a view of encouraging the industry by making better use of the EU single market, with regulation covering all member states. Funding Circle has said the overall future of regulation is unclear, but it doesn’t currently expect any major changes.
Can Funding Circle survive a financial crash or economic downturn?
‘The general economic environment throughout the group’s operating history, in each of the geographies in which the group operates has been characterised by relatively stable conditions, and the group has not experienced severe economic downturns,’ — Funding Circle.
While P2P lenders have proudly pioneered an alternative method of financing following the financial crash, this in itself raises one of the biggest questions causing doubt over the potential of businesses like Funding Circle: can they survive a downturn? Although its UK investor base has diversified over the years it still relies on a small group of investors in the US, Germany and the Netherlands, making it vulnerable in the event of any downturn that would prompt them to pull their cash out of the platform. Addressing this is one element of its four—prong strategy, alongside raising brand awareness, investing in technology, data and analytics, and scaling up to become a global business.
Funding Circle states its models show it is ‘not likely to suffer an aggregate loss as a result of prolonged periods of economic recession’ but concedes that investment returns would be ‘adversely affected’ and it can’t guarantee its models will work, as they simply haven’t been tested in reality yet. However, the business is doing what it can to demonstrate it strength and ability to weather a storm with voluntary UK stress tests, typically undertaken by traditional banks to see how they would perform if another crash occurred. In the worst-case scenario under the latest 2017 test, the result was a twofold increase in net losses for investors with returns falling to 2.4—4.3% — what the company describes as an illustration of its resilient business model.
Its overall borrower base is diverse by both the location of the businesses it lends to and the industry they operate in. Risk is also geared relatively low, with A+ ratings comprising 27% of its portfolio, A ratings at 31%, B ratings at 20%, C ratings at 12%, D at 7%, and E at 3% (on the basis that A+ is the lowest risk and E is the highest).
Some have questioned how current trends (rather than hypothetical downturns) could affect the business. Funding Circle has thrived amid record—low interest rates, helping them attract investors as other assets lose their attractiveness, and offer more competitive loan rates to businesses, but these have now started to rise on both sides of the Atlantic.
Bearing in mind that borrowers can repay their loans early ‘without penalty’, changing interest rates could pose a problem. Many will defer borrowing to see where rates settle and others will look to repay their loan early if they know it will become more expensive in the near future following a rate rise. Higher rates would also squeeze its ability to compete with alternative assets that investors can consider.
Funding Circle IPO: leading the P2P lenders
The financial crash is a stark reminder of how important innovation is, both in creating new ways of doing things and ensuring that monopolies do not drag everyone else down. The reasons for its conception and its significant role in plugging the gap of much needed funds for SMEs provides much hope for Funding Circle, but the future is clouded with a lot of the loss—making company’s fate in the hands of undecided regulators which have big considerations like Brexit at the back of their minds.
Funding Circle is a tech firm at heart, which opens up risks in terms of IT networks, with plans to move its entire system onto Amazon’s cloud—computing services shortly (some will gulp remembering TSB Bank’s torrid transfer). Other partners, like those providing it with payment processing, also pose possible threats. Also, creating bespoke credit models to determine the quality of new borrowers could suffer if the company can’t get its hands on good data, with less availability in its developing markets than what it has access to in the UK.
Funding Circle is fundamentally a simple business, connecting investors disappointed with the returns on offer with businesses looking for cash as offers from the banks dry up, but it finds itself operating in an increasingly complex industry which will undergo significant change for the foreseeable future — providing both risk and opportunity for investors.