Mr. Osborne’s Budget confirmed what many within the alternative finance space already knew – that the British Business Bank (BBB) is to be instrumental in delivering the government’s plans for supporting the industry. We learned that the BBB will henceforth be taking the reins of the mandatory referral scheme. The bank has now opened its doors to applications from “finance platforms” and “credit reference agencies” that wish to serve as the recipients of rejected-for-finance SME data. The BBB also has a fresh £100m of firepower to distribute to high potential firms via the “Help to Grow” pilot – and is now accepting proposals from “private sector delivery partners”.
So this felt like the perfect time to catch up with Keith Morgan – CEO of the British Business Bank. In a wide-ranging discussion at the Bank’s Salisbury Square offices, Keith touched on everything from the overarching purpose of the organisation, to its specific activities within the alternative finance sector, to his take on how the industry will evolve.
The BBB works with a vast range of finance providers – both the old and the new. Mr. Morgan outlined two key concerns for the bank: to develop an empirically informed view of specific markets and to identify methods of improving their functionality. The organisation channels money through startup funders, angel syndicates, venture capital firms, asset finance providers, supply chain financiers, trade credit providers, peer-to-peer lenders and banks of the challenger and traditional variety.
The Bank always allocates its resources via intermediaries – in order to leverage their expertise within their respective specialty markets. Direct distribution of the BBB’s funds would be both costly and competitive. Partners are chosen extremely carefully.
Working via choice distributors also entails a multiplier effect. The BBB’s funds are always co-invested alongside private sector money – money that has been sourced by the delivery partner, whether it be an alternative financier, a VC or a bank. The idea is to maximise the impact of the taxpayer’s pound. The Bank may allocate funding in two ways. A co-investment situation – simply funneling money into SMEs alongside private sector funds via a delivery partner. Or, alternatively, the BBB may opt to unlock a much larger loan by guaranteeing a reasonably specific proportion of the risk.
Across the BBB’s mandate are two central objectives. Number 1, to increase the availability of finance that is available to small businesses. Number 2, to spur on diversity and choice within the market. Mr. Morgan sees these core objectives as intertwined and complimentary.
The British Business Bank looks to support the nation’s businesses via a four-pronged approach.
The first area of focus is the startup sector. Mr. Morgan explained that the Bank is looking not only to provide funding but also to facilitate mentorship and support for entrepreneurs. One of the BBB’s delivery channels in this field – Start Up Loans – ticks both boxes. The government organisation offers loans of up to £25k at a 6% per annum fixed interest rate, as well as 1 on 1 entrepreneurial support. A little over 25,000 of these loans have been made so far.
The second focal point is the scaleup space. Keith took a moment here to outline how SME finance needs have evolved over the past 2 or 3 years – transitioning from a widespread requirement for working capital to the need for growth capital. The BBB has reacted accordingly, exploring innovative methods of facilitating the funding of growth. Keith made particular mention of the Bank’s involvement with the Angel Co Fund – an angel syndicate with which the BBB has thus far invested £20m. One step further up the growth ladder, the Bank works with a number of VC firms. The BBB has in fact provided around two thirds (approximately £25m out of £37.5m) of the money that Eileen Burbidge’s Passion Capital has poured into high growth firms.
And we must not overlook the “Help to Grow” scheme, which was also unveiled in Mr. Osborne’s latest Budget. The product is designed to inspire lending activity at what some would describe as the “mezzanine” level of finance – loans between £250k and £2m – for high-growth firms that are reluctant to take on equity funding but lack the capacity to take on certain forms of debt.
The British Business Bank has £100m of capital to deploy alongside private sector money via the “Help to Grow” scheme. And the Bank is now accepting applications from private sector delivery partners that believe themselves capable of facilitating this type of lending. The BBB anticipates two types of applicant. The first is a provider that has enough money to lend but is uncomfortable with the risk, in which instance the BBB can (for a fee) offer a guarantee and reduce the downside risk for the delivery partner. The second type of applicant may not have enough liquidity to lend, in which case the BBB can supply a fresh chunk of capital. In such a situation, given that the BBB always invests alongside private sector money, Mr. Morgan would be prepared to rebalance returns so that the private sector gets exposure to more of the upside than the BBB.
And then we come to the established businesses. Within this market segment the BBB’s activities are geared around creating a diverse market with a greater range of choice. To that end, the Bank has already issued over £200m of awards to the alternative finance space – the recipients being Zopa, RateSetter, Funding Circle, MarketInvoice and Urica. The Bank has also sent money in the direction of asset-based finance providers like Shire Leasing and non-bank lenders that operate a fund structure, such as BMS Finance. The BBB has fielded applications from over 100 prospective delivery partners. It is looking for partners that satisfy the criteria of the programme, that deliver an appropriate reward to the taxpayer, that entail an acceptable level of risk, and that fulfill the strategic objectives of the company.
Finally we have the Bank’s Enable programme. The key feature here is that the BBB will share risk with the major banks by issuing guarantees in order to reduce the amount of capital that the bank has to put aside in order to cover a small business loan. Such collaboration allows the banks to deliver a greater level of SME lending from the same pool of capital.
That final point brings us nicely onto the next theme within the interview – how does the BBB perceive the alternative space stacking up against the banking sector? How would the BBB like to see the alternative movement play out?
I first wanted to gauge Keith’s opinion on whether the banks actually have an appetite for scaling up their SME lending operations. The BBB’s “Enable” scheme, and the movements of, for example, AMP Credit Technologies, seem to suggest that they do. But contemporary data – such as the quarterly breakdown of the Funding for Lending scheme – conversely suggests that the banks are retreating further and further from the small business lending arena.
Mr. Morgan offered a reminder that the banks remain a hugely important conduit of small business lending. The main issue, as identified by the BBB, is not that they don’t have enough liquidity to lend, but rather issues around capital adequacy. Hence the British Business Bank’s “Enable” guarantees.
I also asked Keith how he envisages the alternative finance industry developing in relation to the banking sector. He pointed to the examples of collaboration that we’ve already seen (the RBS and Santander tie-ups) as evidence that the banks are thinking hard about how best to align themselves with dynamic alternatives:
“I think we find ourselves in a very interesting position where, as the alternative finance segment develops, banks or lenders that are perhaps more traditional in their format will of course be looking at the alternative finance space, and they will be trying to understand how they should be working adjacent to it, alongside it and in partnership with it.”
“The financial services industry is going through an era of potentially great change. Technology is starting to have an impact on the way that services are delivered. The more traditional providers of finance will have to look very closely at these developments and work out how their business models sit alongside it.”
So, can we expect more alignments? Partnerships? Takeovers?
“All of the above!”
The BBB boss emphasised that his focus is on trying to create a crucible within which simmer the perfect conditions for competition and innovation. The BBB’s focus is on the small businesses, and on the creation of a greater array of funding choices for that small business.
Driving up competition and choice is important, but it’s only half the battle. Educating prospective fundraisers about the range of offerings on the market is every bit as substantial a challenge.
But as AltFi readers will know, the government has a plan – and the British Business Bank is acting as its implementation device. As the recent Budget revealed, the BBB is now accepting applications from “finance platforms” and “credit reference agencies” (CRAs) that wish to receive bank data on SMEs that have been rejected for finance.
The CRA initiative is all about ensuring that credit information on small businesses is made as widely available as possible within the market. The BBB is looking to ensure that SME data reaches the full gamut of potential finance providers.
The “finance platforms” initiative is of course very different. 2 thirds of SME owners go straight to their bank when in need of funding, and 35% of those entrepreneurs fail to examine the alternatives when rejected. But the mandatory referral scheme will soon come into effect, obliging the banks to offer rejected small business owners the option of having their details forwarded on to the alternative finance space.
“Once again we’re not prescribing the marketplace that will form. We’re creating the conditions in which we’d like to see a marketplace form.”
The BBB is working closely with HMT to clarify exactly what information will be passed on by the banks, and of course to designate a series of platforms as the recipients of that information. Those platforms will then be tasked with making the data widely available within the alternative finance space. Mr. Morgan made it clear that the BBB has no blueprint in mind for exactly how this information dissemination process will function. Indeed, he instead looks forward to receiving a diverse mix of proposals:
“The action of creating a request for proposals is designed to generate innovation in the marketplace. We expect and hope to receive a whole series of innovative proposals.”
“What I hope to see is a range of proposals. People coming forward with interesting, perhaps different value propositions. That will allow us to designate a series of finance platforms that will bring diversity, variety and different options to small businesses.”
Changing tack and tempo slightly, I wanted to get a sense of how the British Business Bank’s activities within the alternative finance world have played out so far. Some quick-fire Q and A.
How does the BBB make use of its returns?
“The reason that we are investing in this area is that we want to catalyse activity in the alternative finance space. When we invest our money, we are accepting exactly the same financial return that other providers of finance are expecting. And when we earn that return, it becomes part of the income that the British Business Bank generates across its programmes. So where we are earning income, we can then reinvest it into more of these programmes to build our impact over time.”
On what terms does the BBB invest?
“We are obliged to invest in a commercial way and on the same terms as the private investor.”
Has it been difficult to put money to work?
“So far we’ve found opportunities to put our money to work. In total, when you add up where we have played in the alternative finance space, we’ve put to work approximately £100m.”
It seemed fitting to finish by quizzing Mr. Morgan about how he sees both the alternative finance space and the British Business Bank’s activities within the space evolving.
He reiterated that the BBB has attempted to play a catalysing role, and as such has been extremely pleased with the tremendous growth in topline delivery within the alternative sector. But he noted, as did the recent “Conduct and competition in SME lending” report, that the industry is still at a very early stage in its development – and remains dwarfed in scale by the traditional lending space.
For Keith, the most impressive facet of the alternative industry’s growth has been the value that small business owners clearly perceive within the various funding structures. Whether it be convenience, speed or flexibility, the platforms themselves are resonating with UK entrepreneurs:
“We’ve got a very interesting situation where the actual business model itself seems to be valued by the borrower, by the small business. And I think that’s almost the most important element of this. We can see that there is a very, very strong endorsement of the service by the people that are using it.”
Eventually, through word of mouth, through widespread endorsement, through referrals and reviews and support, sustained momentum reaches an inevitable tipping point. The BBB will continue to play a pivotal role in sustaining the supply side of the alternative finance equation. But Mr. Morgan believes boosting demand to be every bit as crucial. As such, the BBB sees improving awareness of, and confidence in, the broader range of funding providers that are now available to small business owners as fundamental to the continued development of the alternative finance sector.
AltFi is returning to Amsterdam for its second annual Summit in the city. The inaugural event last year was a roaring success, with key figures from across Continental Europe's alternative finance and digital banking sectors highlighted. These included Jeroen Broekema, managing director of Funding Circle Netherlands, and Mieke van Engelen, head of innovative partnerships at ABN AMRO's standalone lending platform, New10.