Venture capital firms have come to see small business lending as an industry ripe for a shakeup, given the slow pace of lending since the financial crisis and unmet demand for credit, which is estimated at billions of dollars a year. Funding Circle, a British peer-to-peer lender, is the latest to benefit: The company announced on Wednesday a new $65 million dose of capital from Index Ventures and other firms.
Funding Circle’s online platform lets individual or institutional investors fund loans that meet its underwriting standards. So far it has lent more than $525 million, mostly in the U.K., since it was launched in 2010.
In the U.S., where the company began making loans last year, business owners can borrow up to $500,000 over three to five years at rates ranging from 10 percent to 21 percent, plus a 3 percent origination fee. The average loan amount has been a little less than $150,000, says Sam Hodges, who founded the company’s U.S. operation.
Funding Circle’s backers argue that innovative new lenders can take customers from stodgy financial institutions. “The real competition is banks,” says Neil Rimer, a partner at Index Ventures, which led Funding Circle’s current financing round. “That’s where the vast majority of this business has been transacted for centuries.”
That’s changing. It’s getting more and more likely that a small business owner’s next loan won’t come from a bank. It might come from a merchant cash-advance company, or a nonprofit, or a peer-to-peer lender like Funding Circle.
Funding Circle isn’t the only company hoping the peer-to-peer model will work on Main Street. Lending Club, the San Francisco company that has enabled peer-to-peer loans to consumers for years, launched a small business program earlier this year. Dealstruck, in San Diego, has been making peer-to-peer loans to small businesses for more than a year.
What’s less clear is whether the new crop of VC-backed lenders are taking business from established financial institutions, or if they’re merely grappling with each other for a limited number of customers willing to try unconventional loans. If anything, some banks seem happy to outsource their smallest loans to peer-to-peer lenders or other unconventional sources of capital.
The Spanish bank Santander refers some small U.K. businesses to Funding Circle—an arrangement that allows Santander to maintain good relationships with customers that it turns down for loans. OnDeck, QuarterSpot, and other U.S. alternative lenders also have referral deals with traditional banks. Those agreements are important for newfangled lenders that have had trouble attracting wary borrowers.
Differentiating themselves from banks makes a good selling point for companies like Funding Circle, especially given Main Street’s negative view of traditional lenders in the years since the financial crisis. Funding Circle is willing to make smaller loans than most banks are interested in pursuing. The peer-to-peer loans also cost less than some short-term lenders, such as OnDeck, which specializes in loans carrying annualized interest of more than 50 percent. At least some VCs are betting that combination will be enough to win customers and turn a profit.