Funding Circle

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NOVEMBER 2014 BLOOMBERG MARKETS 33

Co-founders Samir Desai, James Meekings and Andrew Mullinger, left to right, are providing entrepreneurs with new borrowing options.

34 BLOOMBERG MARKETS NOVEMBER 2014

The overthrow of British banking is being plotted in between pingpong games in a 10-story office building near London’s Fleet Street. That’s where Funding Circle Ltd., an online peer-to-peer lender, is arranging an average of 1.5 million pounds of loans a day for small businesses, double its pace in September 2013. ¶ On a hot summer afternoon, the startup’s open-plan suite is filled with the chatter of two dozen account reps on the phone with borrowers. Two young software developers are taking a break to play ta-ble tennis. Samir Desai, the firm’s co-founder and chief executive officer, comes rushing through the front door with the jazzed look of a man whose far-fetched plan is actually working. “Sorry I’m late,” says Desai, all business in a blue suit, white dress shirt and pointy black shoes, “but it’s been a crazy day.”

Five years ago, Desai and two of his mates from the University of Oxford, James Meekings and Andrew Mullinger, decided to start their crowdfunding site over pints in a London pub. Instead of ca-tering to cash-strapped consumers the same way U.S. pioneers LendingClub Corp. and Prosper Marketplace Inc. did, the trio, all now 31 years old, targeted en-terprises with at least £50,000 ($81,550) in annual sales that were having trouble get-ting credit from British banks.

Today, Funding Circle is Britain’s No. 1 online matchmaker for small-business loans. From its inception through Sept. 8, it transacted £366 million in lending be-tween 32,000 investors and 5,000 firms, which pay interest rates ranging from 6 to 15 percent. “Some people may still want to sit with a branch manager, but this is a game-changing way for businesses to bor-row money,” says Desai as he walks past whiteboards covered in flowcharts.

That may sound cocky, especially considering that Funding Circle’s loan volume is modest compared with that of established British lenders. The small-business loan book at Santander UK Plc, Britain’s No. 5 bank, stands at £30 billion—about 80 times larger than that of Desai’s startup. But Funding Circle is leading a generation of financial technol-ogy startups that may have only begun to challenge traditional banking’s grip on the movement of money.

Scores of fintech enterprises in Lon-don and Silicon Valley are devising new ways to loan cash, transfer money abroad, settle international commercial transac-tions and score credit risk—all chores that have been the domain of banks for centu-ries. Now, tech giants such as Apple Inc., which in September introduced a new way for consumers to make wireless payments via their iPhones, are jumping in to create alternatives to the existing order.

“Prior to 2008, it was accepted wisdom that if you didn’t have a banking license, a massive balance sheet and a 300-year-old name you couldn’t possibly play in this space,” says Neil Rimer, co-founder of In-dex Ventures, which has invested in more than two dozen fintech firms in Europe and the U.S., including Funding Circle. “But after trust in banks crumbled during the financial crisis, that emboldened en-trepreneurs to start companies and go af-ter them.”

The fintech generation promises to harness the Web to create a faster, eas-ier, more-efficient way for consumers to bank. One key tool: the online market-place model pioneered by auction power-house EBay Inc. By matching lenders and borrowers on a website, Funding Circle can originate a loan for a small business in

three weeks or less instead of the months it can take at a conventional bank. While almost 40 percent of the small companies that sought loans from traditional British lenders were turned down in the second quarter of 2014, according to the Feder-ation of Small Businesses, 100 percent of Funding Circle’s applicants obtained credit from investors.

Betting that global banking—with $50 trillion in assets—is ready for a historic shift, investors are piling into fintech startups. French telecommunications billionaire Xavier Niel and PayPal Inc. co-founder Peter Thiel are backing Trans-ferWise Ltd., a London-based online marketplace that moves money interna-tionally for 10 times less than conven-tional banks. Google Inc.’s venture arm has invested in Upstart Network Inc., a Palo Alto, California–based peer-to-peer firm that uses unorthodox measures such as college grade-point averages to assess the credit risk for recent graduates.

Even old-school bankers are joining the revolution: John Mack, the ex-CEO of Mor-gan Stanley, sits on LendingClub’s board, and Richard Kovacevich, the former CEO of Wells Fargo & Co., is an investor in Daric Corp., a crowdfunding venture based in Redwood City, California. Investment in

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fintech startups may hit $4 billion world-wide this year, double the level in 2012, according to a forecast by Accenture Plc. And entrepreneurs are eyeing the first major fintech IPO: San Francisco–based LendingClub, valued at $3.8 billion in April, may go public by the end of the year.

With terms of less than five years and average net yields of 9 percent in a zero-interest-rate market, peer-to-peer loans have become desirable fixed- income bets, says Cormac Leech, an an-alyst at Liberum Capital Ltd., a London–based investment bank. New York–based BlackRock Inc. and British hedge-fund firm Marshall Wace LLP are just two of the players committing clients’ capital to this emerging asset class. Leech forecasts that peer-to-peer loan volume on the top U.S. and U.K. sites will explode to £267 bil-lion from £5 billion in the next decade and eventually account for a quarter of all con-sumer and small-business loans. “A wall of money is coming,” Leech says.

In London, the world’s No. 1 interna-tional banking center, new ventures are materializing every month in the hipster haven of Shoreditch as angel investors and venture capitalists pour money into British fintech firms at twice the clip for those in Silicon Valley, Accenture says. Entrepreneurs and investors network in a never-ending stream of receptions and conferences at the scene’s clubhouse, Level39, an accelerator perched atop Ca-nary Wharf’s highest tower. (See “Pizza and Pitches,” page 36.) London Under-ground stations are festooned with Trans-ferWise advertisements that capture the rebel vibe: “$camm€d. Your bank is se-cretly overcharging you on international money transfers.” There are more than three dozen peer-to-peer lenders in the U.K., including Zopa Ltd., a nine-year-old firm that pioneered the model. “Banking is ready for massive disruption,” says Ta-avet Hinrikus, TransferWise’s co-founder, who was employee No. 1 at Skype Technol-ogies SA in a previous life.

Fintech has won a powerful ally in U.K. Chancellor of the Exchequer George Os-borne. In speeches and policy statements,

Osborne has expressed his frustration with Britain’s Big Four—HSBC Holdings Plc, Barclays Plc, Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc—for squeezing credit to small and medi-um-sized companies. In the first half of this year, net lending to enterprises with less than £25 million in annual sales shrank by £1.3 billion even though the Bank of England has bestowed banks with cheap capital through its Funding for Lending Scheme.

In August, Osborne unveiled legislation that would require lenders to refer bor-rowers they reject to peer-to-peer firms and other alternative finance providers.

“People are using technology in new ways to communicate, to form social groups, to shop—why not new ways to bank?” Os-borne said in an Aug. 6 speech at Level39. “It means being able to bypass traditional banks altogether and lend money directly through peer-to-peer platforms like Fund-ing Circle and Zopa.”

It’s going to be tough to disrupt an in-dustry as entrenched as banking. In the U.K., the Big Four control 80 percent of the lending market. “I’m positive about this financial innovation, but there is a little euphoria going around,” says Thor-ston Beck, a professor of banking and finance at City University London’s

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E Kaizen Furniture Makers' Antonius Wubben borrowed £100,000 through Funding Circle for a special piece of machinery.

AT THE RING OF A BELL, SERVERS SET OUT

cold beer and hot pizza in a lounge on the 39th floor of One Canada Square, the pyra-mid-topped tower that anchors Britain’s banking citadel in the Canary Wharf com-plex. It’s networking time at Level39, an ac-celerator devoted to bootstrapping financial technology startups that aim to change the way consumers and businesses borrow, lend and manage their money. As skinny young coders scoop up slices and

mingle with venture capitalists on this Fri-day afternoon, Eric van der Kleij is in his element. As chief executive officer of Level39, Van der Kleij is the ringmaster of London’s bubbling fintech scene.

“This networking is everything,” says Van der Kleij, 53, dressed in a jet-black suit and a midnight-blue shirt. “There are CTOs, who mentor the entrepreneurs,” he continues, gesturing toward some chief technology officers chatting by a window


Eric van der Kleij is networker-in-chief of London's burgeoning fintech scene.

could tap the fixed-income market to raise capital. So they hit on the idea of using a peer-to-peer approach to form a virtual syndicate for more-diminutive enter-prises. “We wanted to create a bond mar-ket for small businesses,” Desai says.

To do so, they’d have to establish a

Cass Business School. “If this really ex-pands at a rapid speed, then more- marginal companies will get loans, too. So we have to be realistic about questions of scale and risk.”

Banks themselves are moving to co-opt the fintech surge. In December 2013, Bar-clays joined forces with Techstars, a U.S. and European accelerator, and launched the first in a series of three-month boot camps that will help startups develop busi-ness plans. In July, Santander UK, a sub-sidiary of Madrid-based Banco Santander SA, created a $100 million fund to invest in fintech ventures around the world. “We’re good at assessing credit risk, but the whole idea of innovation isn’t a natural skill set for any large bank,” says Steve Pateman, Santander UK’s head of banking. “So we want access to different ideas, and we’ll seed those that give us more options to ex-pand our business.” One option is Funding Circle. In July, Pateman sealed a partner-ship deal with Desai in which Santander UK will refer borrowers it turns down and Funding Circle will send the bank poten-tial customers.

Back in 2009, Desai was watching the fallout from the global financial crash with a sense of opportunity. Desai, who studied economics and management at Oxford, specialized in the inner workings of banks at Boston Consulting Group and Olivant Advisers Ltd., a London-based pri-vate-equity firm. He saw how small busi-nesses were paying a price for a crash not of their making as wounded lenders with-drew credit. That August, loan approvals to small and medium-sized companies fell 13 percent. Desai says he wondered, What if someone used an online market-place to provide these borrowers with an alternative?

Desai, a cheerful man who used to or-ganize riverboat parties as a class social secretary in college, brainstormed with two friends at The Thomas Cubitt, a gas-tropub in London’s Belgravia neighbor-hood. Fellow Oxford graduate Meekings was a senior consultant at OC&C Strategy Consultants in London, and Mullinger, a mathematician who transferred to the University of Manchester from Oxford, was on the regulatory risk team in the U.K. operations of Nomura Holdings Inc. The three friends noted that large companies

secondary market where lenders could trade the loans the same way bondholders do, Mullinger says. Otherwise, investors would be loath to fund debt they couldn’t sell. “For this to work, we had to pro-vide liquidity,” says Mullinger, a Le Mans auto-racing aficionado. “Without that, I

with a panoramic view of the Thames, “and there are engineers and developers. They bump into people here that they should know. I call that orchestrated ser-endipity. It’s gold dust for us.”

A one-time programmer who realized his talent lay in marketing and business development, Van der Kleij headed U.K. Prime Minister David Cameron’s Tech City UK initiative before joining Level39 in 2013. Although this accelerator nurtures startups by helping shape their business plans, it’s a very different animal from Y Combinator in Silicon Valley or TheFamily in Paris. Level39 is a wholly owned subsid-iary of Canary Wharf Group Plc, a property development company. Rather than taking equity in its startups, Level39 aims to raise companies that may eventually become tenants in Canary Wharf Group’s projects. That’s why the accelerator can

occupy—gratis—two floors in one of the priciest office buildings in Europe.

Canary Wharf Group’s experiment may flop, but it won’t be for lack of trying on Van der Kleij’s part. His calendar is a mar-athon of fintech conferences and recep-tions: In August, he hosted a speech by Chancellor of the Exchequer George Os-borne. What the Dutch native truly savors is promoting his young companies. Walk-ing the halls, he rattles off elevator pitches and funding levels for his charges like a trainer sizing up thoroughbreds at Ascot.

“Fireflock offers a different take on crowdfunding by allowing investors to take early-stage equity,” Van der Kleij says, pointing to an office door adorned with a flame logo. “It’s going to be a superb plat-form.” Nodding toward another space oc-cupied by eToro, a currency-trading site, he says, “They just got $30 million in

funding; they’re flying.” He even trumpets the foosball table in the accelerator’s rec room. “Look at their legs,” he says, point-ing out how each plastic player has an an-gled foot. “That’s excellent for chipping. Do you see that?”

More than 680 startups applied to Level39 for entry to its 2013-to-2014 term. It accepted 97. One graduate, Pirean Ltd., a company that provides software security to its clients, has leased 210 square meters (2,260 square feet) at One Canada Square.

As Van der Kleij finishes his rounds, he pops in on a cybersecurity outfit called Digital Shadows Ltd. CEO Alastair Pater-son tells him they’ve just won a contract to help the Bank of England test its digital vulnerability. “Can we shout about this?” Van der Kleij says as he high-fives Pater-son. “You’re killing it!”

EDWARD ROBINSON


Sources: Bloomberg, companies

wouldn’t put any money in it myself.”Still, Desai and Mullinger were ner-

vous about leaving their cushy jobs for a startup. So Meekings says he found a way to force their hand. “I quit my job and told them that if you’re not coming along, I’m doing it myself,” says Meekings, a

lanky, fair-haired man who competes in triathlons.

The three men formed Funding Circle in September 2009. Over the next year, they set up a risk analysis system that grades borrowers from A+ to C– by vacu-uming up at least 400 bits of data, such

as credit-card-payment history and le-gal judgments. They established a web-site where lenders scroll through a menu of potential borrowers. Funding Circle charges borrowers a 2 to 5 percent fee and lenders a 1 percent annual rate. Like bond-holders, the investors receive a coupon-like

PEER-TO-PEER LENDING INVESTORSFUNDING CIRCLE Arranges loans for small companies, including many rejected by banks. Index Ventures, Accel PartnersZOPA Provides consumers with a funding alternative to credit cards. Arrowgrass Capital Partners, Benchmark CapitalPLATFORM BLACK Enables smaller firms to sidestep bank loans by borrowing against future sales. GLI Finance

FOREIGN EXCHANGETRANSFERWISE Moves money internationally for one-tenth of what banks charge. Billionaires Peter Thiel, Xavier NielKANTOX Permits small businesses to trade currencies at market prices rather than at bank-set rates. Cabiedes & Partners, Partech Ventures

PAYMENT SYSTEMSEARTHPORT Offers banks a fast and relatively inexpensive system for settling cross-border payments. Henderson Global Investors, BlackRock

ACCELERATORSLEVEL39 Showcases fintech startups and hooks up entrepreneurs with investors at its Canary Wharf clubhouse. Canary Wharf GroupSTARTUPBOOTCAMP Mentors startups during three-month sessions, then connects them to a global VC network. Amazon.com, Google

T H E C H A N G I N G L A N DSCA P E I N T H E WO R L D ’S I N T E R N AT I O N A L BA N K I N G CA P I TA L I S AT T R ACT I N G I N V EST M E N T AT T W I C E T H E R AT E O F S I L I C O N VA L L E Y. SC O R ES O F E N T R E P R E N E U RS , V E N T U R E CA P I TA L I STS A N D STA RT U P AC C E L E R ATO RS H AV E M AT E R I A L I Z E D I N T H E C I T Y, A L L W I T H A C O M M O N A I M : TO R E I N V E N T T H E WAY M O N E Y I S LOA N E D, M OV E D A N D E XC H A N G E D.


payment; as of Sept. 8, their average net re-turn was 6.4 percent. “We wanted to allow people to be banks,” Meekings says.

Those investors loan money to compa-nies such as Kaizen Furniture Makers Ltd., a 35-employee firm that designs and builds custom furnishings. Amid the whir of band saws in a workshop outside London on a summer morning, Kaizen co-founder An-tonius Wubben places a hand on a hydrau-lic press the size of a minivan. “This is our baby,” he says. When Wubben decided in 2013 that Kaizen needed the state-of-the-art Austrian machine to apply veneer to pieces of wood, he turned to Funding Cir-cle for an uncollateralized loan, bypassing his bank, NatWest, a unit of RBS. He posted

a loan request on Funding Circle’s website. Less than three weeks later, 612 investors ponied up £100,000 at a 9.1 percent inter-est rate. Now those investors are trading Kaizen’s debt on Funding Circle’s second-ary market, which handles about a fifth of the site’s total loan volume.

In under five years, Desai and his part-ners have set up a lending alternative that’s growing so fast they’re desperate to find more office space to accommodate all their new hires. Thanks to the ruthless efficiencies of the Web, they’ve done so without the costly branch networks and capital requirements that burden com-mercial banks. Funding Circle and its on-line peers are originating loans for 40 percent less in costs than traditional lend-ers, according to Liberum Capital’s Leech. With a 1.4 percent default rate, Funding Circle has demonstrated that it can man-age risk, he says.

Even so, Funding Circle has far to go. It isn’t expected to record a profit until 2016, according to a forecast by Leech. If fintech firms in general are going to change the way we bank, they’re going to have to col-laborate with the institutions that have the market power and regulatory standing to deploy capital measured in the trillions and not millions, says Hank Uberoi, former co–chief operating officer of Goldman Sachs Group Inc.’s technology division. He’s now the CEO of Earthport Plc, a London firm that’s built a digital hub designed to

settle cross-border payments faster, more cheaply and with greater transparency than the current system. Earthport already counts HSBC, Bank of America Corp. and the World Bank among its clients.

Uberoi says fintech startups and banks need each other. “The problem with banks is complexity, and this is exacerbated by the hundreds of mergers they’ve made in the last 30 years,” he says. “Bringing about changes in such complicated organizations is incredibly difficult, if not impossible, to do, and that’s why banks need to be open to new solutions.”

At Funding Circle in July, Desai is putting the finishing touches on an announcement that shows how some fi-nance veterans are embracing this new world of banking: Robert Steel, the one-time vice chairman of Goldman Sachs who’s CEO of New York–based private- equity firm Perella Weinberg Partners LP, is joining Funding Circle’s board.

Desai has big plans. Funding Circle, which late last year began expanding into the U.S., plans to push into asset-backed lending and property development debt. Asked if the inevitable next step might be an outright acquisition by a bank, Desai laughs. “If they can afford us,” he says, trot-ting off to yet another meeting.

Edward Robinson is a senior writer at Bloomberg Markets in London. [email protected]

Finding Funding Circle’s FundersYou can use the Private Company Screen-ing (PSCR) function to determine the venture-capital backers that are investing in companies such as Funding Circle. Type PSCR <Go> on the Bloomberg Professional service. If you have criteria saved in the Se-lected Criteria section of the screen, click on the X’s to the right of the items to remove them. Tab in to the NAME/DESCRIPTION field, enter SOCIAL LENDING and press <Go>. As of Sept. 8, three companies matched that criteria. Click on Funding Cir-cle Ltd. for a window that displays a list of funds that have invested in the lender. Click on Index Ventures V for a description of the 2009 VC fund. JON ASMUNDSSON

I N T H E WA K E O F T H E F I N A N C I A L C R I S I S , AS BA N KS L E N T L ES S A N D L ES S TO S M A L L A N D M E D I U M - S I Z E D E N T E R P R I S ES , STA RT U P S S U C H AS F U N D I N G C I R C L E E M E R G E D TO F I L L T H E G A P I N T H E M A R K E T.

Funding Circle’s Loan Volume (in millions)

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British Banks’ Net Lending* (in millions)

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*Loan amounts after repayments are subtracted from total lending. Sources: Bank of England, Funding Circle

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Funding Circle