P2P Money Blog

Evolutis, one of the latest peer-to-peer providers, specialises in lending to "professional services".  They have produced a white paper entilteled "the case for lending to professional service firms" and it is an interesting read for lenders looking at lower risk investments.

Small businesses need credit.  This has been true since the beginning of time, when merchants borrowed money to buy stock to transport across seas and deserts to sell in faraway markets.  Today, like then, the problem for small businessmen is securing the loans they need at prices that make commercial sense.

Before the financial crisis of 2007/2008, there was a one stop shop to borrow money.  Your local high street bank would make money available to an enormous range of businesses at very attractive rates, and take practically anything as security.  Banks lent freely and easily against payment due, stock in transit, shop floor display products, work in progress and a whole host of other assets - almost anything that had a value.  This was because US and other banks wanted loans of pretty much any type to put into securitised asset pools that could be sold as bonds.

After the crisis, investors realised that many of these loans were extremely difficult to collect upon, and the pendulum swung the other way.  Banks now are extremely reluctant to lend on anything but real estate assets.  For many small businesses, this is a threat to their very existence.  Good, solid businesses that have existed for decades suddenly are starved of one of their raw materials, capital.

But the problem wasn’t that the assets or the loans were fundamentally flawed, the problem was that the banks didn’t know, and in many cases didn’t care, about how to underwrite them.  So long as they could sell loans to the securitisers, they kept on originating, knowing that if the loan went bad it would be somebody else’s problem.

Within the small business world, there are all sorts of niches of profitable lending that can be carved out.  The trick is to pick a niche with enough opportunities to build a profitable business, without carving such a big “niche” that the characteristics within it are so diverse that you can’t truly get your head around the issues.

The need for borrowing by professional services firms

One niche that has proved extremely interesting is the area of professional services firms - Doctors and other medical professionals such as dentists, accountants, lawyers and vets.  At first sight, this might not seem like a very fertile sector for a potential lender to look at.  The common perception of professionals is of a wealthy chap, driving a Mercedes or a Jaguar to the golf club and living in a nice big house in the more fashionable parts of town.  Surely he doesn’t need to borrow money?

He might not, but his business does.  Medical practices are full of very expensive kit.  A dentist’s chair costs around £10,000, for a chair, before you even start with compressors, drills, suction machines, X-rays et etc.  New EU laws mean that many dentists are having to upgrade their sterilisation equipment, at costs of up to £50,000 per practice.  Like most small businessmen, dentists tend to take the profits out of their businesses as income each year, so there is unlikely to be money in the company to fund this kind of capital expenditure.

What about the lawyers and accountants?  Other than a few cheap laptops and leased photocopiers, surely they don’t have expensive kit that needs to be financed?  Well actually they do - it’s just that their expensive kit puts on coats and walks out of the office every night.  The biggest cost to most accounting and legal practice is the salary bill.  They employ well qualified, expensive people who need to be paid every month. This would be easy to manage, but in the case of lawyers invoices are often only raised when a transaction or case is completed, and accountants are often only paid when the company report and accounts are finalised.  Any interim invoices along the way typically only fund a small part of the costs to date.

In the “old days” pre credit crunch, these businesses would have funded these costs with an overdraft or the more sophisticate firms might have used some sort of work in progress financing facility.  These are now as rare as hen’s teeth.  Hence the opportunity for non-bank lenders such as Evolutis Lending to step in and lend to these businesses.

Is the market big enough to be interesting?

The table in Figure 1 shows the number of professionals in each sector, and the number of firms employing them.

Figure 1: Number of UK Professionals and Firms

As can be seen, there are nearly 50,000 firms in the target sectors in the UK.  In the pre-2007 days, almost all of these had some form of borrowing, be it an overdraft, business development loan or similar.  The average size of loan application we have seen from these kinds of practices is between £20,000 and £25,000.  In order to be conservative, if we assume that only 50% of these companies are potential borrowers and they might borrow £15,000 each, then the total market size is £375 million.  In fact, we believe that the market is much, much larger because if these firms were able to borrow they would do so.  Once they know about Evolutis, they will not just be more likely to borrow, they will borrow bigger sums to grow their businesses.

Will professional services firms pay lenders back?

There is an old saying in banking that it’s easy to lend money, getting it repaid is harder.  So the question is how safe are professional services firms compared to other borrowers in the UK.  The UK Insolvency Service collects data on how many people and companies don’t pay what they owe and go bankrupt.  The data is shown below in figure 2: