Thinking of buying into the Funding Circle IPO? Read this first

Peer-to-peer lender Funding Circle fired the starting gun on its much-anticipated plans to go public earlier this month. The company, which is only eight years old, is looking to attract a value of £1.7bn and raise £300m in the process.

Since its founding, Funding Circle has transformed the market for business financing, matching everyday investors who have money to spare with businesses looking for funding to expand. In total, the company has put together £5bn in loans for small businesses since 2010. 

However, if you’re thinking of buying into the IPO, there are several issues you need to consider first.

Loss-making

For starters, Funding Circle is not profitable. In 2016, the company lost £46.6m. Although losses narrowed in 2017 to £35.3m as revenues increased from £50.9m to £94.5m, management isn’t targeting profitability anytime soon. 

Indeed, in the IPO prospectus, the company says that it will use the proceeds of the float to “enhance its balance sheet position,” which will support its strategy of “pursuing growth over profitability in the medium term.

So, while revenue is expected to expand at a rate of around 40% per annum in the medium term, I wouldn’t bet on the company breaking even anytime soon.

High costs

The main reason why the company is struggling to break even seems to be because it’s spending so much trying to attract new customers.

Marketing spending totalled 40% of revenues last year. The company believes that as it matures, spending on customer acquisition will decline as repeat borrowers become the majority of its clientele. Currently, repeat custom constitutes about 40% of revenue. With minimal marketing spend required for repeat customers, Funding Circle estimates this group is around three times more profitable than new borrowers.

Spending on marketing to customers is certainly something to keep an eye on.

Quantity over quality

Funding Circle’s business model is another red flag for investors. The company matches investors with borrowers and most of the interest generated is passed back to investors. 

With this model, Funding Circle’s primary source of revenue (over 80%) comes from transaction fees paid upfront when the loan is agreed. This encourages the company to make new loans — if the flow of new loans stops, profitability will plummet. 

This setup could encourage greater risk as the firm chases quantity over quality. It also means that the company is hugely exposed to business cycles.

Peer problems

Funding Circle isn’t the first peer-to-peer lender to break out into the public domain via an IPO. Two US peers, OnDeck Capital and Lending Club have also decided to go down this route. Their performance is hardly reassuring. Since going public in 2014, shares in Lending Club have declined by around three quarters, and OnDeck has lost 60%. Both companies have struggled to attract new investors to their platforms and, as a result, growth has slowed. 

Funding Circle believes it can do better, but based on these previous examples, I’m not so sure.

Conclusion

After considering all of the above, I think it’s probably best to avoid Funding Circle’s IPO. The company might be one of the UK’s fastest growing fintech brands, but with losses set to continue for the foreseeable future, shareholders may be left wanting.

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Rupert Hargreaves owns no share mention. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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