Will the failure of crowdfunding trigger the next recession?
On average, recessions occur once every decade. Given the financial crisis in 2008, history suggests the next recession is now overdue.
Multiple clouds are currently looming on the horizon; Brexit uncertainty, various trade wars and falling industrial production amongst others. Whether psychological or actual, these have a knock-on effect on both business and consumer confidence.
Pre-2008 the main source of lending to SMEs was bank lending. Post-2008 the combined effects of cautious banks and the low interest rate environment have opened the door to crowdfunding. In recent years, the majority of companies we have encountered at Gibson Hewitt owe a significant sum to crowd funds.
The “uncertain economic environment” has been quoted by Funding Circle as a cause of reduced demand for loans giving rise to a 50% reduction in its growth forecast. This has been reflected in a share price fall from 440p in 2018 to a recent 120p.
Of course the difference in the pre-2008 world was it was the banks who were risking their own money. With peer-to-peer lending, the individual investor is risking their own capital. The failure of Lendy in May 2019 resulted in a lot of, (often unsophisticated), investors getting their fingers burned. In some cases, individuals lost their life savings as there is no FSCS, (Financial Services Compensation Scheme), protection for such investments as there would be for funds in a traditional savings account.
The failure of further peer-to-peer platforms could result in a domino effect into the wider economy because it would have a dual effect as follows:
- The debtor businesses would likely have their loans re-sold as occurred after the 2008 Northern Rock failure. Inevitably the terms would become more onerous for many as per the good bank/bad bank separation and as refinancing options reduce. This could then render these debtor businesses unable to maintain the loans leading to default.
- The consumer investors, (crowd-funders), would lose their investments. Whilst these investors might not be high percentage of the population, they are affluent and therefore represent a disproportionately large part of the UK’s discretionary spend. Therefore the reduced demand in the UK economy’s supply/demand balance would be magnified.
To protect themselves, consumer investors should diversify to spread the risk and limit exposure.
On the other side of the lending equation, limiting exposure to this risk is more difficult for entrepreneurs as refinancing is not easy. We would therefore recommend reviewing your business’ forecasts with a critical eye. Perform “stress tests” on an ongoing basis to understand the effects which would arise in a variety of scenarios such as:
- Your lender increases interest rates by 2%
- One of your main customers goes bust and you write off their debt
- Sales fall by 10%
If you have concerns about the viability of your business, it is vital that you take professional advice as soon as possible. The options to rescue the business become more limited if you try to soldier on and exhaust the company’s reserves. Gibson Hewitt offers a free initial meeting where we can discuss and advise on your options. Call Lynn Gibson on 01932 336149 to arrange a free initial meeting.
