It was a traditional non-bank finance company for over a quarter century after it was started, but its business model underwent a complete change and it has transformed itself into a lender to small businesses.

D Lakshmipathy, who joined Five Star Business Finance in 2002 as Executive Director, was responsible for this change. As Chairman and Managing Director now, he has raised two rounds of external funding, brought in professionals to run the day-to-day operations and strengthened the board with experts in different fields. Five Star Business Finance has also got into housing finance.

“When I joined Five Star in 2002, the company was struggling to find a good business model,” says the 42-year-old Lakshmipathy.

The challenge was to raise capital to grow and for that the business model needed a re-look. In 2010, Lakshmipathy decided to try out lending to small businesses – roadside eateries, small restaurants, vegetable vendors, carpenters, pharmacies, small provision stores – and when this model proved viable, he completely pivoted the company’s business strategy. Five Star is now a lender to the unorganised sector, getting collateral for the loans it gives.

The need for capital among owners of small businesses, says Lakshmipathy, is always high. “That is an opportunity for us,” he adds.

Funds from Matrix, Morgan

As a validation of Five Star’s business model, in February 2014, venture capital firm Matrix Partners India invested an undisclosed sum of money for a significant minority stake. In June 2016, Morgan Stanley invested ₹114 crore for a minority stake; together Matrix and Morgan Stanley have put in ₹165 crore into the company for a 51 per cent stake.

From six branches in 2010, the company has grown to 81 branches across Tamil Nadu, Karnataka, Andhra Pradesh and Telangana. The number of customers has increased from about 2,000 to 10,000 in this period. Its loan portfolio has jumped from about ₹25 crore to ₹300 crore.

“We are a small business lender and we have a significant bias towards services,” explains K Rangarajan, Chief Operating Officer, who joined Five Star recently and has nearly 15 years experience in the financial services industry. Almost 95 per cent of the portfolio, adds Lakshmipathy, is from the services sector. “We have 50 categories of customers, starting from a plumber, electrician, roadside vendor, barbers, pharmacy shop,” he says.

“We do not just lend based on business income, machinery or stock. We try and understand the business model. I would say 100 per cent of our customers cannot offer income proof,” says Rangarajan. That is, they have an income and a regular cash flow, but no proof of income as a salaried employee.

According to him, Five Star will lend to any small business that has cash flow and has property to offer as collateral. All the loans are fully secured. The typical loan size is ₹4-5 lakh with a maximum tenor of seven years, and the interest is 22-26 per cent.

Five Star has its own way of assessing the cash flow and repayment capacity and does a lot of surrogate checking before approving a loan. It doesn’t specify the end use as long as the borrower is clear how the money is going to be paid back. By March 2017, Five Star expects to have a loan book of over ₹400 crore.

The company has over ₹200 crore of capital, says G Srikanth, Chief Financial & Information Officer, who also joined Five Star recently and who has nearly 15 years corporate experience.

Portfolio target

By 2020, Five Star targets to have a portfolio of ₹3,000 crore, at least a third of which will come from its recently started housing finance division. It will start operations in Kerala, have about 250 branches and nearly 50,000 customers. It now borrows from 18 banks and NBFCs.

The challenge as they grow? The biggest is to recruit, train and retain the employees needed to spur this growth, says Lakshmipathy. He is confident that as Five Star’s credit rating improves, it will be able to bring down borrowing costs and, in turn, pass on the benefit to its customers.