Why lending through sites like Funding Circle can help boost British business

Growth is essential for the UK economy to recover from recession, but in order to achieve this banks must lend - particularly to businesses - to help stimulate the economy. Sadly, the latest figures show that lending to businesses fell by £3 billion in the three months to May this year.

But what if you could help where the banks are failing?

Funding Circle

Social lending and borrowing has become increasingly popular over the last few years, which is hardly surprising considering the attractive rates on offer and our growing disillusionment with the banks.

This alternative method of borrowing and lending generally means individuals can help support other individuals. But, perhaps more interestingly, it can also allow you to support businesses.

While Zopa and RateSetter deal with person-to-person lending, Funding Circle is the main player in the arena of matching businesses that need to borrow with lenders that would like to invest.

Its business model is quite simple. The website acts as an online marketplace to help businesses seek out low cost loans quickly and investors to get better returns.

What's in it for me?

It's all well and good knowing that your money will help fledgling firms and, hopefully, the economy as a whole. But just as important is the fact that you'll get a decent return on your money too.

If you've been keeping track of the latest best buy savings rates then you will know that investing your money into traditional savings accounts will bear very meagre rewards at the moment.

Currently, the best easy access savings rate is from West Bromwich Building Society, which pays 3.22%. If you're happy to lock your cash up for two years, then the AA will pay a beefier rate of 3.8%. Typically if you are able to lock away your money for longer then the rates improve. If you have £25,000 and can do without your money for five years, you could earn a top rate of 4.6% with a Bank of London and The Middle East Five-Year Premier Deposit Account.

In contrast, investors using Funding Circle earn a gross yield of 8.8%, can sell off the loan to get the money back within two days and can invest as much as they want (with a minimum of just £20). Even after the 1.0% fee and the risk of bad debt, this is still much better than what the banks have on offer at the moment.

The risks

Those better rates come with risks though.

Investing through Funding Circle is not the same as depositing money into a savings account. It's more like investing in corporate bonds or gilts, where there are risks of losing money and variable returns.

However, the risk can be managed and minimised.

Funding Circle does its part by only allowing solid, credit-worthy businesses into the marketplace. This is determined through an in-house team of underwriters and thorough credit checks. Also, the businesses must meet the minimum criteria before being approved; a company must not have CCJs over £250, the company must have two years minimum trading history, there must be evidence the business can afford monthly repayments, and a thorough check of directors associated with the company is required to eliminate the risk of fraud.

To help investors make an informed decision Funding Circle also gives each business a rating from A+ (low risk) to C (average risk). The A+ loan risk band typically pays lower returns (around 7.3%) while a C-rated company will be able to offer a better yield (typically of 9.4%) but at an increased risk of a business defaulting.

The average current loss rate at Funding Circle is 0.9%. You can use the statistics provided by Funding Circle to see what bad debt is associated with each profile of company through a feed updated every hour and incorporate this figure into the rate you put on offer to businesses so you can minimise the risk.

Arguably, lending to an individual rather than a business would vastly reduce risk, but the returns also dwindle. With RateSetter ,for example, you would have to look into a five-year income plan to get a rate of 7.3% gross. Using Funding Circle you can get this return on a low risk business and get access to your money by selling off the loan parts to other investors, which only takes a few days.

Investors are also encouraged to reduce risk by spreading their investment among a number of different businesses. For example, if you invested £5,000 you could lend £20 to 250 businesses, minimising the risks of losses.

The regulation problem

Another thorny issue for peer-to-peer lending is that the service is not regulated by the Financial Services Authority and not covered by the Financial Services Compensation Scheme. This means if a business like Funding Circle went bust investors could lose everything.

But this is something peer-to-peer companies have campaigned to improve. Zopa, Funding Circle and RateSetter have grouped together to form the P2P Finance Association, which sets minimum standards for its members, such as keeping client accounts separate from company money, and having arrangements in place to ensure the loans can continue to be serviced even if the broker goes bust.

Even riskier alternatives

Funding Circle only really caters for businesses that have been established for two years and are doing moderately well. But if you like the idea of supporting the economy and you’re a bit braver there are a few riskier alternatives.

Seedrs is a fairly new online trading platform. Here you can invest from £10 to £150,000 in businesses that are just starting out and have no cash funding, which is obviously quite a large risk to take on.

Another avenue is to utilise a Venture Capital Trust (VCT). VCTs are vehicles used to invest in a number of small companies that are often start-ups, which makes them pretty high risk. This is not for your average small-time investor but for people who have a lot of money and can cope if the businesses fail (which a large number will). There are a number of tax benefits that makes this scheme attractive but to take advantage of them you need to stay invested for at least five years.

Would you invest in business?

Clearly, with sites like Funding Circle there is the chance to earn a good return on your cash. Is that return worth the risk associated with investing in businesses? Or do you feel better, knowing that your cash is helping a business grow? Would you ever invest in this way? Or is your money safer with a bank? Let us know your thoughts in the comment box below.