The Risk of a Vicious Funding Circle in Fintech

(Bloomberg Opinion) -- There are fintechs, and then there are fintechs. Cheerleaders point to payments startups like Jack Dorsey's Square Inc., whose stock has soared 242 percent in a year, as evidence of a Silicon-Valley-style revolution in the making. But there are sob stories, too: loan platforms LendingClub Corp. and On Deck Capital Inc. are still trading well below their IPO prices. Promises of break-neck expansion often crash into the reality of regulated finance.

The Risk of a Vicious Funding Circle in Fintech

Funding Circle Ltd., Britain's biggest provider of online loans, hopes to break the curse of its U.S. peers. The company said on Monday it is preparing an IPO that may value it at as much as 1.7 billion pounds ($2.1 billion) – the highest valuation that Danish billionaire Anders Holch Povlsen is prepared to accept in return for buying a 10 percent stake in the IPO.

The firm's impressive past growth is the attraction: revenue surged 59 percent in 2016, and almost doubled in 2017. The IPO would raise about 300 million pounds to keep that growth going. Profits, or rather losses, would take a back seat.

The Risk of a Vicious Funding Circle in Fintech

To justify the price tag, investors need to believe in a story of future growth. Hitting that 1.7 billion-pound figure requires a lot of optimism that extra marketing and foreign expansion will deliver. Funding Circle's revenue last year was just less than 100 million pounds. A multiple of 17 times trailing revenue looks enormous next to LendingClub's 1.3, On Deck's 1.7, and even Square's 13.

Keeping up rapid pre-IPO growth rates in a maturing industry is hard. LendingClub and On Deck's adjusted revenue growth slowed from triple-digit rates in 2013 to the mid-teens by 2017. They aren't perfect comparisons in terms of risk and growth, to be clear. Funding Circle doesn't offer consumer loans, and its focus on small businesses in Europe means it's exposed to a still young and fast-growing market. But the competitive environment is getting tougher, and continental Europe – an area that is growing faster than the U.K. – will be a battle-ground for many platforms.

The Risk of a Vicious Funding Circle in Fintech

There are plenty of known risks in the marketplace lending industry, not least the fact that platforms like Funding Circle haven't experienced a proper downturn before. Talk of how algorithms make for better risk managers than experienced humans or institutions is still meaningless given how benign the current cycle has been. Still, the broad range of institutional investors and asset managers throwing money at this kind of platform, and the real retrenchment of banks from lending, suggest few believe these platforms will be wiped out.

The unknown factor here is more what the real rate of growth is for a sector that has experienced both high euphoria and crushing disappointment on financial markets. There's still plenty of investor optimism to go around, and Funding Circle will have scarcity value in Europe. But the virtuous circles of the past – burning cash to grow fast – can still turn vicious.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Lionel Laurent is a Bloomberg Opinion columnist covering finance and markets. He previously worked at Reuters and Forbes.

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