The Prospa Float Reveals a New World of Online Business Funding

While large banks typically seek SME customer security in the form of a family home and take several weeks to process applications, Prospa lends up to $100,000 unsecured, makes a credit decision in 15 seconds and places funds in the client’s account the next day.

For such convenience, customers pay a high price. Prospa’s average annual interest rate percentage was 41% at the end of 2017, down from 45% six months earlier and 59% in 2016.

Bertoli said quick access to funding and confidence that loans will be approved are more important factors for his clients than costs.

“Our research shows that price is one of the lowest considerations,” he said. “There is this misconception that price is the only factor that comes into play… We offer a risk rate and a price over a very wide range of risk rates.”

Prospa, which is backed by private equity owners Entree, Airtree and SquarePeg, said on Monday its retail offering would be open to clients of Macquarie Equities, Crestone and JBWere; certain other investors chosen by the company; and its employees. Others will have to wait for the shares to hit the public market.

Take an extra risk

Several fund managers surveyed by The Australian Financial Review last week urged caution, suggesting that a corollary of rapid loan book growth could be a high level of bad debt, especially if economic conditions deteriorate.

Another risk is the possibility of greater interest rate regulation as a result of the Royal Banking Commission, or more transparent disclosure of the annual percentage interest rate, as Prospa describes rates to clients in the form of a “factor rate”, which critics say makes them look cheaper than they actually are.

Prospa’s loan impairments for 2017 were $11 million, or about 20% of revenue.

According to market sources, Prospa seems more willing to take on riskier loans. The prospectus says 21% of loans are in the construction sector, with a further 20% in hospitality. Any bad debts built into the rapid growth of the loan portfolio in recent quarters may not yet show up in the numbers.

Prospa says it is aiming for a “static loss rate” of between 4 and 6% and that it wants overdue loans over 90 days to be between 6% and 8%.

Co-CEO Greg Moshal says unsecured small business loans shouldn’t be viewed as “inherently riskier, but more complicated to understand. [small business] ready. We obviously have to plan for future business cycles, and we have the right parameters in place for any potential future business cycles that may arise.”

Prospa’s prospectus acknowledges that the way it discloses interest rates to customers may change. Such a decision “could have a material adverse effect on distributors’ or borrowers’ perception of the cost of Prospa’s products relative to other financial products,” the document said.

Prospa and other online commercial lenders are currently working with the Small Business Ombudsman to finalize a new code of conduct, which should see interest rates disclosed based on the annual percentage rate (APR) as well as methodologies alternatives.

“We’ve always been in favor of transparency and we’ve always believed that giving the customer what they get and refunding them is the most transparent way to show it,” Moshal said. “But we’re very comfortable working with the ombudsman to get to a point that we feel as an industry, we have strong representation across multiple interpretations, and to make sure the client has everything what he needs to understand the contract and the pricing, and know what they’re getting into.”

“We feel we are at such an early stage”

Fund managers say the potential for increased bad debt and increased regulation should be watched by potential investors.

“The valuation at 2.5 times their book value seems high and this is mainly due to three factors: their original dependence on brokers, the short duration of loans, which they must constantly replenish to expand, and the lack of historical data on delinquent loans,” said Sebastian Evans of NAOS Asset Management.

“There is also a risk of further industry regulation, including Austrac, the royal commission and possibly more laws regarding their contracts and unfair pricing.”

But current Prospa investors are keeping the faith. Venture capital fund Entre Capital has subscribed for $32 million in shares as part of the raise, its pro-rata right, meaning it will own 34% of the publicly traded company; Airtree brought in an additional $3 million, giving it an 8.4% stake, while SquarePeg increased its stake from 3.2% to 4.4%, after an additional $10 million investment.

Mr. Moshal and Mr. Bertolio have sold about 2% of their respective stakes and will together own more than 20% of Prospa.

“Keeping the vast majority of our shares was very important to us because the value is yet to come,” Moshal said. “We think we’re at such an early stage.”

Of the free float proceeds, $60 million will go towards investing in the core business, with $40 million allocated to growth in New Zealand and new product development.

Mr Bertoli said Prospa had only made loans to 1% of its addressable market of 1.1 million small businesses “so this product is still in its infancy in terms of outreach, distribution and scale it can achieve.

“We will continue to invest in the core business to grow our product, engineering and design teams to continue to deliver more value to products and customers.

“We are very proud of what we have achieved. Getting to this point is an important step, but it is also only the beginning. Chapter one is written. We are now entering chapter two.”