Can crowdfunding still thrive if interest rates rise?

Interest rate rises are very much back on the agenda in 2017 amid a sharp climb in inflation in recent months.

Having experienced a benign environment where headline inflation was below the official target of 2% between 2014 and 2016, even dropping into deflation territory at times, the Consumer Prices Index inflation reading has been on a steady upward trajectory since last May. It currently sits at 2.3%, and has been tipped to climb further still.

Policymakers are taking note, and just last month external Bank of England policymaker Michael Saunders told the Confederation of Small Businesses that growth and inflation will be stronger than expected, before strongly hinting that the Monetary Policy Committee may well take action in the coming months by raising rates.

Against this backdrop of record low interest rates and weak inflation, crowdfunding has enjoyed breakneck growth. Businesses have been able to offer rates to income-starved investors which satisfied the need for a higher income than cash provided, whilst also giving companies an attractively priced line of credit.

So will a shift in interest rates spell trouble for the sector? Below, David Walker of law firm Memery Crystal, which has been involved in a number of successful equity and debt raisings, and Ayan Mitra of Code Investing, the alternative investing platform, give their views on the likely impact of any rate rises.

David Walker, Corporate Partner at Memery Crystal, a London-based law firm which has worked across a series of capital raisings for the likes of The Jockey Club, and Surrey County Cricket Club:

“The duration of a corporate mini-bond is typically between 3 and 5 years and offers an interest rate on average between 5 and 7.5% per annum, so the base rate would need to increase sharply before it significantly impacted on such debt offerings.

“Indeed, there is likely to remain a gulf for the foreseeable future between the interest rates commonly available on the high street, and those on offer via mini-bonds. That said, although it is not generally expected that there will be an imminent rapid increase in the base rate in the UK from its current level of 0.25%, it is worth remembering that interest rates fell from 5.5 % in May 2007 down to 2% in December 2008, so they can move quickly.

“Even if rates were to rise substantially, companies and sports clubs which investors care about and which offer a viable commercial investment proposition remain in a strong position to raise finance via the issue of corporate mini-bonds.

“Where we may see more of an impact from higher rates is in the less transparent equity fundraisings within the alternative finance sector, where dividends may not be expected to be paid for some time (if at all) and the upside for investors is primarily derived from a sale or listing.

“If interest rates available from banks increase, the public’s view of speculative equity investments could become more discerning – with perhaps more institutional money replacing that which is currently being invested by the general public.”

Ayan Mitra, CEO of Code Investing, the alternative investing platform focused on growth SME Debt which launched in 2011 and has raised £84m to date for businesses looking for capital:

“In theory alternative platforms, like other incumbents, are subject to the same market movements that are affected by LIBOR and inflation. How they are affected and how they react depend on how they work.

“If platforms are pricing the risk (namely setting the coupon and the covenants in case of debt, or the valuation in case of equity) then they can either proactively predict and reset their pricing based on expectations of other offers resetting their prices, or else react based on customer behaviour (which may be borrowers and investees going elsewhere where they get a better price, or investors and lenders deploying capital elsewhere).

“Our pricing of risk is set by the market as part of our credit underwriting process and therefore any adjustments in LIBOR and inflation rates will naturally filter through and reflect in our pricing.

“However, in general the cost of borrowing will increase if rates rise, and this will bring challenges to SMEs and start-ups because of the corresponding rise in savings rates. Capital may very well be redeployed into more traditional channels, and this could exacerbate the funding gap for smaller companies.”