How to get better returns and help small firms

Social lending allows you to achieve 8 per cent or more on your savings, while giving the economy a boost. By Simon Read

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Small businesses are still finding it tough to get loans from mainstream banks, despite the banks agreeing earlier this year to help kick-start the economy by assisting fledgling operations. But while the banks are still not opening their doors, some small businesses are finding the crucial cash they need online through the growing phenomenon known as social lending. For individuals who become involved, it can actually mean getting much better returns on your nest egg than with traditional savings accounts.

Small businesses are crucial to the country's economic well-being. But without adequate financial help they can quickly collapse, meaning lost jobs and unpaid bills. Without a healthy small business environment, the chance of economic recovery is slim, which is why the Government persuaded the big banks – Barclays, HSBC, Lloyds Banking Group, Royal Bank of Scotland and Santander – to agree to new lending targets under under the Project Merlin agreement in February.

But on Monday, the first Bank of England lending figures published since the agreement revealed that the banks had failed to keep their end of the bargain. Total loans for small and medium enterprises (SMEs) in the first quarter of the year came in at £16.8bn. But the banks had promised to lend £19bn. The news prompted anger: "When banks won't lend, small businesses and jobs can't grow," said Lord Oakeshott, a Liberal Democrat peer.

John Walker, the chairman of the Federation of Small Businesses, said: "Unless there is a fundamental shift in the make-up of the banking sector in the UK, small firms will continue to struggle to access affordable finance."

One solution is social lending, or peer-to-peer lending, where individuals rather than banks lend to small businesses. The social-lending concept has been around in Britain for more than six years with Zopa (uk.zopa.com) – which brings together people prepared to lend with those looking to borrow – now representing 2 per cent of the UK's personal loan business (see below for more about Zopa). You don't lend the whole amount yourself, but bid for parcels of a deal, spreading your risk among different borrowers.

Apart from the fact that social lending sidelines the banks, both parties involved can win. Lenders can get much higher returns on their cash than with traditional savings accounts. At Zopa, average returns in the past year have been 7. 3 per cent. Meanwhile, borrowers can get much cheaper loans. Zopa reckons the deals offered through its site are at least 20 per cent cheaper than the best rate a borrower may be offered at a bank.

Last year saw the concept taken a stage further with the launch of the Funding Circle (www.fundingcircle. com), which allows individuals to offer money to businesses and, as well as decent returns, those lending know they are helping companies, often at a crucial time. About 40 per cent of companies that have borrowed through the Funding Circle have done so to either expand or for growth capital, while a third did so to generate working capital.

"It's a simple proposition which allows individuals to maximise returns on their hard-earned cash while also allowing businesses of all sizes to borrow at lower rates than those set by the banks, with a quicker turnaround," explains James Meekings, a co-founder of the Funding Circle. In the first six months of operating the site, people who have signed up as lenders have offered more than £11.5m to businesses, and have collectively earned an average yield of 8.3 per cent.

Mr Meekings says new members tend to start small, putting in just a couple of hundred pounds or so, then get more involved as they get used to the concept. "Since its inception, when accounts were typically opened with £500, individuals have realised the potential of the platform and have increased their account size to an average of £3,500," he says.

The Funding Circle suggests that lenders spread their risk over about 20 deals, and lenders can sell their loans on to other members, giving them access to their cash in an emergency. "On average, it takes just two days to access your money with us," Mr Meekings says.

"The cost of a loan is still a major issue for businesses. Although banks may offer a loan to a small business, it is often at an extraordinarily high rate. Because we're online our loans can be much cheaper, from 7.3 per cent.

"However, we can't help small businesses alone – the banks have to get their act together."