Direct financing for small business

rainfinRainfin CEO Sean Emery frequently holds investor meetings with his family who are all investors in small businesses funded through funding platform RainFin. “My mom is an investor and she always asks me “am I making money” and “am I helping people?”

That sums up the concept behind RainFin, a crowdfunding platform which brings investors and borrowers together by cutting out the middleman. It is aimed at investors who want a reasonable return but prefer the concept of social sharing and supporting the growth of online marketplace lending (previously peer-to-peer) as an alternative to banks dominating the lending and borrowing space.

RainFin was the first online marketplace lending platform in South Africa – it was launched in 2012. Initially RainFin focused on personal loans but last year Emery decided to focus primarily on the SME sector in order to provide financing for small businesses. Today the platform has lent out around R140 million to approximately 340 SMEs with an average loan size of just less than R500 000.

The premise is that a small business is able to apply for a loan through RainFin’s platform and investors are able to decide whether or not they wish to invest. The business is assessed on an SME credit score card and affordability, within 48 hours. A loan can be issued for up to R750 000.

The marketplace lending model is not, however, without its challenges – both in terms of finding the right mix of investors and businesses, as well as overcoming onerous legislative changes.

Lowering the cost of loans

Emery believes that the interest charged by banks and microlenders makes it almost impossible for small businesses to succeed and aims at lowering the cost of loans whilst compensating investors for the increased risk of investing in a small business. The challenge is that investors often want unrealistic returns rather than understanding the nature of marketplace lending which is to receive a reasonable return while helping to grow small business.

“Affordable credit is possible, but both parties have to see it as a win-win situation. If you want to receive a 30% return with no risk, it is just not possible,” says Emery, whose average investor return is around 16% per annum. “There are a lot of desperate people out there and many lenders take advantage, but just because you can exploit someone, should you do it?”, asks Emery who adds that many people claim they want to help small business but really they just want to take advantage.

The amount of interest paid by the small business owner to the investor depends on the quality of their business. An A-Grade SME with a good credit record and sound business can qualify for a loan at as little as prime plus 1% while a higher-risk business may only qualify as E-Grade and pay the maximum rate under the National Credit Act which is currently repo plus 21% (28%).

In order to boost the funds available to small business, RainFin is now targeting institutions who wish to invest in small business and RainFin is able to create different investment portfolios that meet the investment requirements of large corporates.

This also overcomes the challenge of new legislation that is being introduced which will effectively destroy marketplace lending in South Africa. Currently an individual is allowed to lend up to R500 000 to another individual/s without being a registered credit provider. Due to abuses to this exemption, with unscrupulous microlenders forging their books to prevent falling under the National Credit Act, the Regulator has amended this regulation and as from November 2016 no-one will be allowed to lend money unless they are registered. RainFin is restructuring its lending platform in consultation with the regulator to still allow individuals to invest in marketplace lending.

Another challenge facing small business is the fact that the law stipulates that if a business has a turnover of less than R1 million they have to be treated as an individual when borrowing money. In other words, they must meet the criteria and have the same rights as an individual, not a business. If your business has a turnover of less than R1 million you would have to apply as an individual on RainFin’s platform, and you will be limited to a maximum loan amount of R100 000 payable over a maximum period of four years. A further issue is that due to the very high-risk nature of start-ups, there is little interest by investors in funding these, so RainFin can only offer the platform to existing businesses.

Investing process

As a borrower:
Minimum requirement for a business loan is that the person has a business account for six months and a turnover of at least R1 million. If your turnover is less than R1 million you can take a personal loan for up to R100 000.

RainFin undertakes a full credit assessment which includes analysing bank statements, invoices and VAT returns. “Even if you do not have an asset base, one can lend money against a good business and cash-flow,” says Emery.

As an investor:
RainFin grades the various loan applications according to a risk profile and investors can decide what level of risk and return they wish to take. The higher the risk of the loan defaulting, the higher the potential return to the investor – so the risk is highly dependent on the investor and the choices they make on the platform.

RainFin publishes a risk grading and interest rate band based on the Grade of the business. The recommendation is that an investor spreads their investment across a range of business loans to lower the risk of one business defaulting. Currently the default rate is 1.9%, which means that 1.9% of loans are behind in payment. The investor takes the direct hit if a loan is not repaid. For example, on the current return of 16%, a bad debt experience of 1.9% means that the total return to the investor is 14.1%.

It is important to understand the nature of the loan repayment which is monthly – therefore an investor receives a monthly income which includes a portion of the capital invested as well as interest earned. As the interest is charged on a reducing balance one cannot make a direct comparison to a normal fixed deposit – the actual interest rate received is not a per-annum rate. The investor will receive a detailed repayment schedule in order to enable him/her to make informed decisions when investing into a specific loan.

Beware invoice discounting

As small businesses face cash-flow constraints there may be a temptation to opt for invoice discounting. This is a practice whereby the small business sells its existing invoices to a third party at a discount. The small business receives the cash immediately but the third party, who bought the invoice, collects the money and makes a 5% return. While a 5% discount may seem reasonable to a troubled SME, if they continue this practice every month it translates into a 60% interest rate per annum. It would be cheaper to borrow money and repay at a lower interest rate.

This article first appeared in City Press