Iwoca, one of Europe’s largest specialist SME lenders, on Tuesday announced a new funding line with initial commitments of £200 million from Barclays and Värde Partners, an alternatives investment manager specializing in credit.
According to iwoca’s own most recent SME Expert Index, more than four in five brokers (84%) say high-street banks are reducing their appetite for funding SMEs.
That is up by seven percentage points from the first quarter of 2023.
We are very much at the data-science heavy end of lending. Time is always of the essence for working capital
Christoph Rieche, iwoca
Back then, iwoca secured an increase from £125 million to £170 million on its existing funding line with long-standing partner Pollen Street Capital as demand for SME finance soared.
This new £200 million funding line now takes the company’s total debt commitments to more than £850 million and equips iwoca to fill at least part of the alarmingly widening funding gap for SMEs.
Across the UK and Germany, iwoca has lent more than £2.5 billion since its launch in 2012 across more than 120,000 business loans. As of the third quarter of 2023, the lender is on track to end this year having doubled the number of small business loans funded compared with 2021.
The withdrawal of bank lenders is a long-term trend, but providing short-term, unsecured working capital to SMEs can be a good business, if lenders have the right technology to make good underwriting decisions and to acquire clients.
“We are profitable and can fund our business growth organically out of retained earnings,” Christoph Rieche, founder and chief executive of iwoca, tells Euromoney. “We don’t need to raise equity, which is probably just as well given that the same pressures subduing IPOs also prevail in the private equity markets. And that helps with debt raising, where several interested parties were looking to provide finance to us on competitive terms.”
Data science
As much as it is a lender, iwoca is a data-science company. “We have always invested heavily in our tech capabilities,” says Rieche. It began by automating credit decisions for micro businesses with maybe a couple of employees selling goods or services on e-commerce platforms that might need £10,000 to meet a cash-flow gap, for example to pay a bill or acquire inventory.
E-commerce platforms are a great source of cash-flow data and customer satisfaction scores on small businesses, as other alternative lenders have found.
It still does that kind of lending, but now also provides loans of up to £500,000 for companies with annual turnover of around £10 million to £20 million.
That is a wide range in types of borrowers.
Those bigger loans may require some human judgement, although Rieche points out that those judgements feed into scores that go back into the automated approval process.
He gives a theoretical example: “Say we see a cleaning company with £10 million of annual turnover applying for a £500,000 loan, but it only has five customers. It may need a human to look at that. If those five customers are all government departments, that’s good. But then if the contracts are all falling due in the next six months, that’s a worry. A machine can’t quite get its head around all that. So, we have people to score those considerations.
“But we are very much at the data-science heavy end of lending. Time is always of the essence for working capital. We don’t invite the CFO and the CEO in for a chat, decide whether we like the look of them and then process loans manually.”
When Euromoney last spoke to Rieche in January, there was uncertainty around likely default rates for this year.
Iwoca models expected losses and operates within a buffer against those. “Loss experience is always the big worry, especially in periods like these of low growth and high uncertainty,” Rieche says. “Our pricing is risk-based, and we model expected losses on each loan and then in aggregate across our portfolio. Our portfolio has performed this year in line with, or slightly better than, our modelled expectations.”
The good thing about short-term working capital is that, even though it is unsecured, iwoca is frequently re-underwriting its borrowers and obtaining fresh insights on their cash flows.
And in terms of appetite to borrow short-term working capital, Rieche says: “We have seen demand growing for 18 months since the closure of government support schemes and it continues to grow. At times of high uncertainty, there is often greater demand for cash-flow finance.”
Good borrowers
The other requirement for cutting-edge technology is to originate good borrowers.
In Germany, iwoca does some work with Commerzbank. CommerzVentures took a stake in the business during its series B venture round in 2015, but in its main market, the UK, high-street lenders are not as keen to outsource to new lenders.
Rieche says: “We work with hundreds of brokers and have bespoke platforms for many of them where they feed us information on borrowers, and we send back speedy decisions on credit approvals. We have invested a lot in that as well as in our API infrastructure for embedded finance.”
Iwoca’s differentiated sourcing and underwriting capabilities give us access to a high-quality portfolio of commercial businesses
Aneek Mamik, Värde Partners
In Germany, for example, iwoca partners with eBay, which can then offer finance from iwoca to businesses selling on the platform through its own dashboard. It also now runs iwocaPay as a form of embedded finance for some SMEs to offer as a choice of payment terms for their own customers. It has an arrangement to do this on Shopify.
“Distribution is changing,” Rieche says. “More businesses will look to obtain finance in the places they spend most time, which may be on marketplaces or with neo banks, rather than with traditional banks. We need to integrate embedded finance for them.”
Banks can still be a source of funding to lenders such as iwoca. Unsecured loans made directly to unrated SMEs require much more regulatory capital for a bank than a liquidity line to iwoca, which is secured against a diverse pool of underlying collateral – albeit those same loans – and comes with other covenanted protections that may require iwoca to cure some defaults and maintain loan-to-value ratios.
Private credit funds like the working capital business, as well as invoice financing, but are not set up to originate loans to SMEs themselves.
Aneek Mamik, global head of financial services and diversified private credit at Värde Partners, states: “Iwoca’s differentiated sourcing and underwriting capabilities give us access to a high-quality portfolio of commercial businesses. This builds on our leading position in providing commercial lending and leasing solutions to parts of the economy increasingly underserved as banks are less able to meet the full spectrum of the demand.”
For a private credit fund such as Värde, the concerns are that the unit economics of SME lending should stand up; that iwoca should be good at risk managing those exposures; but also that it should quickly be able to allocate the funding provided.
If they provide lines to specialist lenders that cannot commit it quickly, the private credit funds do not earn anything.
But with banks retreating, iwoca sees little problem doing that.
