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Beyond Plain Vanilla – Why Special Situations Lending Delivers Better Returns

The rapid expansion of the platform-based lending market has not only been good for businesses in search of capital but also for investors.

The investor appeal of peer-to-peer lending – which comprises the largest share of the debt platform market – is straightforward. With Bank of England base rates set to stay at their current historic lows for the foreseeable future and then rise only in small increments, anyone putting money into a conventional deposit account can expect to see the value of their cash investment outstripped by inflation. Peer-to-Peer platforms, on the other hand, provide a means to secure higher returns by lending direct to businesses or individuals.

Unlike putting cash in a bank account, lending via a Peer-to-Peer platform does involve a degree of risk and for an individual who in financial terms would be seen as a ‘retail’, rather than a ‘sophisticated’ investor, the safest course of action is to lend to companies who are deemed to be the most creditworthy. Helpfully, platform providers categorise lenders according to their perceived credit-worthiness and assign them to interest rate bands accordingly. This enables their lending communities to make informed choices. Many will quite naturally opt for safety first, as long as the return is considered sufficiently attractive.

Sophisticated Lenders

Sophisticated investors apply a different set of criteria. High Net Worth (HNW) individuals have many options when it comes to asset allocation and lending via a platform is just one of them. Typically, capital set aside for lending to businesses will play a different role in a broader portfolio than, say, investment in property or shares, but what the lender will be looking for is the promise of superior returns.

One way to achieve those returns is to focus on special situations. You might characterise this in terms of higher risk equating to higher rewards. But another way to look at it is that businesses will be prepared to pay higher interest rates to a lender (or lenders in the case of platforms) who are prepared to address specific situations that would, in some, cases fall outside the remit of other providers. Thus for a sophisticated investor, special situations lending offers a real opportunity.

Understanding the Opportunity

The key is understanding. The decision to ‘green light’ a loan to any company depends on the viability of the business in question. A company that faces real challenges may, nonetheless, be perfectly viable. An apparently risky loan opportunity may not, in fact be risky at all. Much depends on the underlying health of the business, the quality of the management team and the state of the market. The potential dealbreaker for an everyday/retail investor is that he or she may not be sufficiently well equipped, or informed, to properly assess the situation. Sophisticated investors are much more comfortable committing funds in ‘special’ circumstances.

In Practice

To take an example. One common circumstance that afflicts many successful companies is an over exposure to one or more large clients. The danger is that a client might suddenly turn to another supplier, or worse still, go out of business leaving large, unpaid debts.

This can be devastating in the short and medium term. The business may have a long and successful trading record but the impact of losing hundreds of thousands of pounds in revenue while having to pay staff and bills is, in some cases, a fatal blow. A good management team will formulate a turnaround plan, but they may struggle to secure financial support from banks or equity investors who see only a major problem. The challenge for lenders is to establish whether or not the business in question is truly viable.

Establishing Expertise

This is a corner of the platform lending market where The Route – City wealth club has established expertise. The Route – Finance’s Private Debt Platform connects a community of High Net Worth investors with businesses seeking capital. There is a particular focus on businesses that face special situations, challenges or opportunities.

The Route – City wealth club invites its Members to commit pre-mandated funds. When a business applies for a loan, The Route carries out comprehensive due diligence, covering the market, the management team, and collateral to assess the viability of the loan. It’s a process that enables The Route to address the needs of companies facing special situations while minimising the associated risks.

From investment point of view, The Route targets a return of 15% per annum for Members.

To find out more, telephone The Route on 020 3141 9040

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