BY KIKI LOIZOU, PUBLISHED 15TH APRIL 2012, in The Sunday Times (PDF)

You can auction invoices online instead of going cap in hand to a high street lender. We talk to entrepreneurs who have done just that.

Jessica Witenberg sat in her north London office with a calculator and a pile of bills. On the face of it, Jessnic & Co, her handbag and accessory making business, was doing well.

Yet if she could pay her bills more promptly, trading would be even better. With customers such as Arcadia, owner of BHS, her goods needed to be made quickly, so cashflow was vital.

Eager to avoid the banks, Witenberg called Market Invoice, an online factoring service she had heard about through the Federation of Small Businesses. It was set up to allow companies to raise cash by auctioning their invoices rather than taking out new loans.

“I wanted funds without all the guarantors needed when applying for a bank loan,” said Witenberg. “And I certainly didn’t want a loan hanging over my head during tough economic times.”

A year on, Witenberg is an avid user of Market Invoice, and one of 100 entrepreneurs who regularly use it. Since February last year, the business has seen monthly auction volumes rise from £20,000 to about £3m. The firm, run by two former bankers, recently completed auctions worth £1m in a day.

Witenberg, 38, says the flexibility is exactly what small business owners want in the current economic climate. “With banks there are hidden fees and additional costs that pop up out of nowhere,” she said.

In the auction, buyers compete to determine how much of an invoice’s value they will advance — usually between 85% and 90% — and the fee they will charge, usually 1%-2%. Market Invoice takes a 0.5% cut of the invoices’ face value as a processing fee.

Anil Stocker, one of Market Invoice’s founders, believes transparency is only one reason smaller firms will continue to use it.

“Businesses can save significant sums by using our marketplace rather than getting locked into a captive relationship with one funding provider,” he said. “Traditional factoring as offered by the mainstream banks just cannot compete.” Market Invoice’s buyer pool comprises more than 35 private investors, family offices, hedge funds and asset managers.

Figures released in February by the Bank of England showed a 3% drop in net lending from the five main banks in the final quarter of last year. Project Merlin, the government initiative which set the banks a target of lending £76 billion to smaller companies, fell short by more than £1 billion.

“They missed the target by a bit but I don’t think we should knock that,” said Mark Prisk, the business and enterprise minister. “Small firms want more choice when it comes to raising capital.”

The growing popularity of alternative sources of finance led the chancellor to announce in the budget that £100m of the government’s £1 billion Business Finance Partnership would be passed to smaller companies through non-bank lending channels. Half the money will be made available this financial year, the rest in 2013-14.

The Funding Circle website is hoping to benefit. Since its launch in August 2010, it has helped to raise loans of £28m for about 600 small British businesses through a peer-to-peer lending facility.

The site allows wealthy individuals or companies to offer loans to businesses the banks won’t lend to. More than 10,000 people, who can lend between £5,000 and £250,000 over one, three or five years, have signed up. Charles Dunstone, Carphone Warehouse chairman, and Ed Wray, co-founder of Betfair, recently became investors.

Rick Curtis turned to Funding Circle last July when a bad experience left him reluctant to seek a conventional loan to expand his Brighton business, Ground Coffee House. “We were in talks with the bank and things went round in circles for ages. We were left in limbo,” he said. “We had secured a new site; it could have ruined us.”

Through Funding Circle he obtained £40,000 in loans from 200 parties. The money hit his account in three hours, he said. The system let Curtis choose whether he wanted to settle before the two-week auction period ended. He said waiting usually means getting the best interest rate; he agreed 8%. The service gives lenders an average yield of 8.4% on their cash.

The National Loan Guarantee Scheme, another government initiative, did not attract him. It offers loans to companies with a turnover of up to £50m at interest rates one percentage point lower than outside the scheme.

“I have ethical issues with banks and where they invest their money,” said Curtis, 45. “Peer-to-peer deals and supporting the community are what we believe in.”

According to the Federation of Small Businesses, last year more than four in ten members with a bank loan or overdraft were paying an interest rate of more than 6%; the average across all borrowers was 7%. The same survey of 11,000 companies revealed that only one in ten small businesses obtained a bank loan in 2011.

“Bank loans are outdated and inefficient,” said Samir Desai, one of the founders of Funding Circle. “They don’t meet the needs of small businesses that require the money as quickly as possible.”

Desai, 28, gave one example of a firm that had spent two months discussing a loan with a high street bank, by which time it was so desperate for cash that it opted for the online lending facility. “We got them the money in two weeks,” he said.

John Maltby, managing director of Lloyds TSB Commercial, said traditional bank finance remains critical to the growth and prosperity of small businesses.

“We are taking steps to address the equity gap that is a challenge for some growing firms,” he said. “Whether we are offering loans and overdrafts, more complex trade and supplier finance, or funding through one of the government schemes, we want our customers to have the right range of finance solutions.”