CROSSING THE WATERS
HOW TO FUND YOUR BUSINESS

Walker Morris

Legal News | 09/02/22

Lending money is what you do. Swapping your lender hat for a borrower one requires careful consideration. Navigating the various funding options available with the specialist lenders in the market is about finding the best fit for your business. And what about raising funds via issuing shares? The following sets out the pros and cons of common funding options for consumer finance businesses.

WAREHOUSE LENDING
Loans are originated and sold to a new SPV (special purpose vehicle). The lender provides secured debt into the SPV, funding a pre-agreed percentage based on borrowing base calculations. Top-up funding needed for the balance will be locked in (“subordinated”). Loans are serviced under a servicing agreement entered into with the SPV.

PROS
• Risk is more balanced between parties
• There is a limit on how much the credit provider can make

CONS
• Requires available capital or other additional funding
• Initial set-up costs can be higher due to the relative complexity of the structure and need to ensure regulatory compliance

FORWARD FLOW
A form of asset purchase arrangement. Loans are originated in accordance with pre-agreed eligibility criteria, and those that fit the criteria (“eligible loans”) are automatically purchased by the lender. Pre-funding of the loans is made by the lender at regular intervals, based on pipeline, for 100% of each consumer loan. Loan origination and servicing fees are taken.

PROS
• 100% funded by the lender so better if access to capital is tight
• Risk passes to the lender and the loan sits on the lender’s balance sheet from day one
• Avoids paying interest on debt capital that may not be generating
a return

CONS
• Can be difficult to find multiple funders as the ‘best loans’ are taken by the first lender
• Additional risk for the lender is balanced by a lower return for the loan originator
• Possible loan buy-back clauses for certain non-performing loans

SPOT SALE
A lending business with an identifiable or established loan book can enter into a one-off sale of the loans comprised in it. As with a forward flow arrangement this involves selling the economic interest in the loan but without any ongoing commitment to sell other existing or future loans.

PROS
• Helps active balance sheet management and economic risk passes to purchaser
• No ongoing commitment to sell other existing or future loans

CONS
• Repurchase obligation for ineligible or otherwise recalled loans
• Potential liability for redress events in respect of loans sold

SENIOR LOAN FACILITY
A more traditional secured loan arrangement, to refinance loans which have already been issued or provided as liquidity for entering into new loans. Funds drawn immediately begin accruing interest, so the loan originator may need to fund interest payments for loans that are not yet generating any return.

PROS
• Allows for the syndication of the loan, giving the possibility of a much larger facility
• Control and ownership of the loans is retained (unless an event of default occurs)

CONS
• Requirement to service the senior debt whether or not the projected returns are being made
• Loans may need to be financed from existing capital before being refinanced

EQUITY
Investors inject cash into your business in return for an ownership stake.

PROS
• May be cheaper than debt financing
• Strengthens balance sheet
• Investors can contribute expertise, increase profile and generate opportunities

CONS
• Existing shareholders’ stake in the business will be diluted
• Investors will likely require a say in relation to key matters concerning the business
• Investors may require the ability to “step in” if the business underperforms

AND FINALLY…
Don’t forget the FCA. As a regulated business you need to consider the regulatory impact of any fund raising initiative. You will need to take advice to make sure the structure is compliant and identify if you need to advise the FCA of your plans and/or obtain prior FCA approval, for example if there is a change of control (where a party acquires 20% or more of the shares or voting right in the business).