The Government’s new Start-Up Loans Company Ltd should cause taxpayers to raise an eyebrow at the risk-reward ratio which is heavily skewed towards the borrower, says Simon Culhane Chartered FCSI and CEO of the Chartered Institute for Securities & Investment (CISI).
In an article published in the latest edition of the CISI 40,000 member-strong monthly publication, Securities & Investment Review, Mr Culhane examines the Government’s effort to recognise the entrepreneurs’ dilemma of no track record, so no traditional source of finance, by creating the Start-Up Loans Company Ltd as a special source of finance for young (18-30) entrepreneurs.
Fronted by former Dragon’s Den participant, James Caan, it supports entrepreneurs by providing mentoring and unsecured soft loans from £2,500 to £20,000 to controlling principals or shareholders in the business, typically one to three individuals. Since May 2013 it has lent over £46m in unsecured funds to more than 9,000 individuals’ organisations, the article says.
“However, taxpayers may raise an eyebrow at the risk-reward ratio, which appears heavily skewed towards the borrower. Although the financier is providing risky, soft-loan capital, its return is priced at only 3% over base rate and there is a capital repayment holiday for 12 months. This isn’t the sort of deal that James Caan or his fellow Dragons would contemplate, yet it’s in exactly the same high-risk category for which they would expect a potential high-reward return,” says Mr Culhane.
Mr Culhane raises questions about who is making the lending decisions, saying that the typically three to four panel interviewers chosen at random from their register may not be as financially savvy as one would expect.
Borrowers have found that they tend not to ask questions about viability of the very basic business plans or the ‘what-if’ questions about what happens when they run out of this relatively limited funding provided. Instead, there is a tendency to want to motivate the applicant to do well and say ‘yes’ if the plan looks ‘ok’, which delights the borrowers.
Of those who appear in front of real Dragons, less than 10% receive an offer. The ‘success’ rate of Start-Up company applicants who appear in front of their financiers appears much close to 50%.
However, unlike the Dragons or a bank-lending proposition, there is no requirement for the appointed mentors to track how the business is progressing or how the funds are actually being spent; although there is some move to now requesting quarterly reports. But commonsense start-up lending says that these untried start-ups need monthly financial cash flow and forecast monitoring, from suitably experienced mentors, for the first six months, then quarterly thereafter. This is to spot the early warning signs to guide those inexperienced borrowers from failing either to repay taxpayers’ money or to prove they are ready for second-round funding.
“Given that there is no upside for the Start-Up Loans Company if a business is successful, and with a margin of only 3%, then it can afford only for the odd failure. But is this realistic? Even if we assume that the mentoring scheme is so successful that it halves the normal failure fate, the level of bad debts will be 16% of its loan book – £8m so far – which would be over twice as bad as the Lloyds Banking Group.
“We do need to support start-ups and the idea of helping them is an excellent one. But it’s questionable whether rushing into it without the proper risk-management process is acceptable, thereby risking taxpayers’ money for unsecured borrowers who cannot get funding from anywhere else,” says Mr Culhane.