Supporting SMEs with a New Asset Class for Investors

Linked Finance is Ireland’s leading peer-to-peer source of finance for SMEs. A seasoned CEO, Niall Dorrian comes from a telecoms background, having run international operations for Digicel and served as Director of Mobile for eircom. He cut his finance teeth as Finance and Strategy Director for Diageo. He has been CEO at Linked Finance for four years.

You work with SMEs, and provide a peer-to-peer lending services. Can you explain this a bit more?

Linked Finance is the largest peer-to-peer lender in the Irish market, dealing exclusively with SMEs as opposed to consumers. We do straightforward, “no hassle” finance for SMEs of up to €300,000 across six months to five years.

The Irish market is somewhat different to the UK in that there is very little competition for the banks. The three pillar banks still dominate the SME funding world, providing around 84% of SME credit. So there is a real opportunity for companies like ourselves to disrupt the market with an alternative proposition that meets the needs of SMEs.

But how will you scale? The UK is not the biggest market in the world, but we have more SMEs and much greater liquidity in the system than Ireland. How do you make that work?

We did get FCA approval for the UK market a few years ago, mainly because we wanted to operate in Northern Ireland to create an all-Ireland lending platform. Our plan then was to move into the UK market but Brexit put the brakes on that while we assessed its implications.

We have since realised that there is a lot of competition in the lending space in the UK market, and the bigger opportunities are across Europe. The mature peer-to-peer platforms in Europe are consumer led. There are only a few B2B platforms in European markets, including Funding Circle, but no established major player.

So Europe is the opportunity, especially as the attraction of the service broadens towards cross-border investing as much as cross-border lending. In that context, I think a pan-European license will come down the track, where we could be in Dublin, lending to SMEs in Spain, Italy, Germany etc.

Our short term focus is, of course, to continue to scale within the Irish market, and particularly to deal with it in the context of COVID-19: what’s the real impact on Irish SMEs in the first instance? We will establish our new baseline and grow from there.

“Before the global financial crisis, businesses here were over-leveraged. That is certainly not the case now. Many SMEs particularly are under-leveraged because they got burnt, treated badly by banks and learned the lessons of the past. Many Irish SMEs today have no debt – which is not the right answer either. Debt has an important role to play in any capital structure.”

What is the impact of COVID-19? It seems to me that as a source of income, it’s an opportunity to engage with companies who need your help. But it also changes the risk profile of those companies…

You’re right. The first port of call during the COVID-19 crisis was to look at our current portfolio and what supports we could implement, particularly on very hard-hit industries such as hospitality and tourism.

So we took a lot of proactive steps and offered immediate payment holidays to a lot of those industries. We’re currently working with those businesses around their plans to get back up and running.

Ireland has been locked down since mid-March and we are only in Phase Two of a five-phase approach to relinquishing that lockdown. My view is we need to move more quickly. To be honest, the economic impact is potentially significant, and I think that while the government was pretty proactive in regards to measures to protect employment – salary subsidies for example – the SME sector is lagging hugely behind European peers like the UK, France and The Netherlands.

We’re in a perfect storm here in Ireland, because the election earlier this year resulted in a hung parliament and a new government is still in the process of being formed. This is slowing down decision-making and thus any new legislation to support SMEs. In the UK, you have significant capital guarantees which are not in place here in Ireland, and that is also leading to a redirection of capital. But Irish SMEs are pretty resilient: we will bounce back from this quickly.

In terms of risk, Ireland is an interesting case. Before the global financial crisis, businesses here were over-leveraged. That is certainly not the case now. Many SMEs particularly are under-leveraged because they got burnt, treated badly by banks and learned the lessons of the past. Many Irish SMEs today have no debt – which is not the right answer either. Debt has an important role to play in any capital structure.

So if we can get the right support mechanisms in place to inject liquidity into the market over the coming weeks, that will be an important step in the recovery process.

Even more importantly, looking at the UK, the government schemes were not that successful in terms of deployment of capital until the non-bank sector became involved. They brought speed and efficiency of deployment to the process rather than the typical banks’ 6-18 month planning cycle. Rapid lending is more in demand now than ever.

That leads me to an important differentiator. You mentioned at the outset of this conversation that Linked Finance is about making lending ‘hassle free’; whereas in the old days, we used to buy on the basis of an interest rate. Today, rates are low and business people don’t necessarily even understand the numbers…

I think it’s a really important  general point about SMEs’ ability to understand their finances. They’re very good operationally, but understanding the ins and outs of their balance sheet is not top of their priority list.

Equally, interest rates are not what they used to be 15 – 20 years ago. So, price is not the key differentiator for the buyer. The difference on a £100,000 loan at 6% against 7%, is not particularly material on a monthly basis.

What is important, though, is the access to capital. The skill and time to budget, create cash flow forecasts and develop business plans is not necessarily within the business. So when banks are asking for 3-to-5-year cash flow forecasts and business plans, and you have to get external advisors to put them together,  that takes an awfully long time. Then you’ll probably have three meetings and three or four months to get a decision.

And what business has a five year plan today?!

Exactly! The world is changing so fast that a five year plan doesn’t have any value or meaning. It’s a checkbox exercise. So the ability to apply online, to fill in a form in two minutes, upload some bank statements and accounting information and get an answer is a world of difference.

Our mission is to educate business owners that it can be that simple. We’re still trying to change people’s perspective that the only place they can get a loan is the bank. The UK is probably three years ahead of Ireland in that evolution and penetration of the non-bank sector.

Currently, we provide credit decisions within 24 hours. Open Banking is another game changer. Again, Ireland is behind the UK, but it will come. My view is that business finance transactions are going to be instantaneous. My cloud accounting package, for example, will have access to my bank accounts and produce my cash flows automatically. It will spot the need for finance, apply directly, and I’ll get a decision in minutes. I will sign an electronic contract and the money will appear in my account. I think that businesses will be able to go through the full process from application to drawdown in under ten minutes. That is certainly where we plan to be as a business and where the industry will eventually end up.

Open data is the game-changer we all require, because every other aspect of life has sped up. In business finance, I think we’re only scratching the surface of what’s possible. The simplicity and ease of access to capital is going to rapidly change over the coming months.

I want to talk about the peer-to-peer aspect of your business because I feel that’s the real difference: you need to match two groups of people; buyers and sellers of money. How do you build liquidity?

Interestingly, in the first couple of years, Linked Finance was 100% funded through retail money. Then  as we scaled up, we brought in institutional money and we now blend that institutional money with retail money.

Linked Finance started just as we were coming out of the financial crash, and the banks weren’t lending. Our expectation was that borrowers would be queuing round the block looking for money and that the challenge would be bringing the investors in. Actually, it was the other way round.

In the Irish context, there was, and still is, over €100BN euros in consumer deposits in Irish banks. So there’s plenty of liquidity in deposits, and particularly in a very low interest rate environment which will potentially turn negative.

Having the opportunity to make a return on deposits is attractive in a very simple way that allows us to open up an asset class. Traditionally, you put your money into a black hole – somebody manages it, but you might only get a report on its progress annually. With a peer-to-peer platform, you have full control over the businesses in which you invest. You can see the company information, their story, their financials, their balance sheet. Our investors can build up a portfolio as they see fit, depending on their risk profile.

So we have created an asset class in Ireland that allows people to be more in control of their money and earn returns that were much more difficult to access previously. Therefore, getting investors and lenders interested has not been challenging and, to be honest, we’ve never put huge marketing money behind that aspect of our business.

The challenge in the Irish market has always been the borrower – and showing to them that there’s a real alternative source of funding.

Right now, in the era of COVID-19, the retail lending sector has really stepped up in terms of supporting  loans. The banks have realised that they are helping businesses to survive – there is a social welfare role that the lending sector can play. My fear was that retail money would dry up in the current crisis, but that has not been the case.

“The world is changing so fast that a five year plan doesn’t have any value or meaning. It’s a checkbox exercise. So the ability to apply online, to fill in a form in two minutes, upload some bank statements and accounting information and get an answer is a world of difference. We’re still trying to change people’s perspective that the only place they can get a loan is the bank. The UK is probably three years ahead of Ireland in that evolution and penetration of the non-bank sector.”

You’ve been very candid and current in your comments about the lending business and its response to COVID-19. What can you also tell us about the Irish fintech scene more broadly?

It is vibrant, particularly at the seed stage. There is plenty of support: Enterprise Ireland would be recognised as perhaps the second or third largest VC fund in the world.

So there’s plenty of activity, plenty of very capable staff, and an educated workforce here in Ireland. It’s really important that observers recognise that the reason Google, Facebook and LinkedIn – and so many other major US tech giants – have their European headquarters here. It’s not just about tax. Of course tax plays a role, but there are plenty of other low-tax jurisdictions. Tax incentives would not overcome all those other talent, lifestyle and infrastructure benefits if they were not there; and Ireland should be justly proud of the environment it has created.

There are aspects that our government needs to improve around entrepreneurial and share options incentives, and there’s plenty of lobbying going on in that respect. As I said before, politically we are in a little bit of a logjam at the moment.

The other bottleneck for us is licensing for fintech firms. Brexit has brought Ireland an influx of businesses from the City of London and our Central Bank is therefore inundated with applications for operational licensing. That’s not helping us, because clearly Dublin must compete with Luxembourg, Frankfurt and Berlin etc.

So there’s still more we could do to remain competitive, particularly in attracting fintech startups at the outset, rather than moving here later in their growth phase. But it’s a very positive environment with superb infrastructure, plenty of reasonable property especially outside the centre of Dublin and with great tech campuses. Our bottlenecks are short-term, the opportunity here remains a strong draw.