Today, businesses face real challenges when it comes to sourcing traditional bank finance. In the past, owners of small and medium-sized enterprises (SMEs) who were seeking a loan would instinctively turn to one place– their local bank. This is very much still the case for the vast majority of SME owners.At present, the largest four UK banks account for more than 80% of main banking relationships in the SME market. This is largely because most SME owners continue to approach only these banks when seeking new funds. However, since the 2008 financial crisis, mainstream banks – constrained by new and burdensome regulations – have not been able to deliver these funds to the same extent as they had done so previously. The result is that a large number of loan applications are rejected. For first time SME borrowers, the rejection rate stands at around 50%. Despite the fact that a proportion of these are viable, they simply no longer meet the new, more stringent risk profiles imposed by the largest banks. As such, many SMEs that have viable loan propositions are unable to receive funding from traditional bank sources. In response, we have seen a new breed of alternative finance providers stepping into the market to fill the funding void by offering non-bank lending solutions
“Alternative finance” or “AltFi” is the umbrella term used to describe financial services that reside outside of the traditional banking system. Technically, even a practice such as collecting offerings from church-goers on Sunday mornings could be described as “alternative finance”, though, generally speaking, the term is reserved to characterise the growing number of platforms through which lending and borrowing takes place between private individuals and organisations.
Crowdfunding, P2P (peer-to-peer) lending, and Dragons’ Den style business angels are perhaps the most well-known examples of what is meant when we talk about alternative finance. There are significant differences between the business models of these varying categories of alternative finance (see ‘Understanding the Alternatives: A Guide to Alternative Finance Platforms’), however, the purpose of each remains the same – to connect those in need of finance with those who have money to invest.
Such non-bank lending options are becoming increasingly well-established and indeed popular – especially over the past three or four years – as more businesses are beginning to realise the benefits of the faster, smarter, and more accessible routes to finance that the burgeoning AltFi sector provides.
But there is one category of alternative finance that doesn’t get enough attention – namely, Sophisticated Investor to Business Lending.
What Exactly Is Sophisticated Investor to Business Lending?
The short answer to this question is this: It is a practice whereby finance is lent to businesses from a closed network of high net worth, sophisticated investors, either on a debt or equity basis.
Long answer? Let’s break down the definition to understand what this type of lending really involves.
What Is a Sophisticated Investor?
A sophisticated investor is an individual who has sufficient experience and knowledge in investing to appropriately weigh the risks and merits of an investment opportunity. He or she will know exactly how to evaluate and value a business, and will understand the risks involved through investing in it. That understanding includes an appreciation of the risk that he or she could lose all money invested.
Usually, before a person can be classified as a sophisticated investor, the individual must meet income and net worth parameters. For instance, to qualify as a sophisticated investor the individual must have a net worth of £1 million or more, and/or must have earned in excess of £200,000 in the past two years.
Alternatively, an individual can “self-certify” as a sophisticated investor if he or she has:
Been a member of a business angel organisation.
Made more than one investment in an unlisted company.
Worked in the private equity sector.
Been director of a company with turnover of over £1 million
Self-certification just means that the body overseeing the investment in question has reasonable belief that the individual qualifies under one of the above requirements.
A financial advisor can also certify that a client is a sophisticated investor. Recognition as a sophisticated investor means that the individual will be eligible to buy into certain investment opportunities that are not available to retail investors, who do not qualify for the distinction due to smaller net worth and/or lack of experience.
In short, a sophisticated investor has an understanding and appetite for risk, capacity for loss, and/or a solid history of investing experience.
Because investors in this type of lending are closer to and more aware of each investment, businesses seeking to access funds from a Sophisticated Investor to Business lending platform will undergo thorough rounds of due diligence. The purpose of this process is to determine the funding requirements, assess the project, identify existing assets that may be used as security against the loan and establish the exit, premium, and other key term.
Only when the project has passed due diligence will it be put in front of sophisticated investors, who will then decide if they are interested in the opportunity or not.
So, What Is Sophisticated Investor to Business Lending?
A Sophisticated Investor to Business Lending platform will field loan applications from businesses. Those that pass due diligence will be presented to an exclusionary syndicate of pre-qualified, sophisticated investors, who will use their experience to make their own decisions on whether or not to invest, on a case-by-case basis.
Much like a dating website, Sophisticated Investor to Business Lending platforms play matchmaker, bringing the capital of sophisticated investors directly to businesses in need debt or equity financing.
The Route – Finance: A Sophisticated Investor to Business Lending Platform
The Route – Finance is a Sophisticated Investor to Business Lending platform. Through our syndicate of sophisticated investors, The Route – Finance facilitates the lending of funds to businesses that require short term finance. Investors mandate a certain amount of capital to The Route – Finance’s Private Debt Platform (PDP), and The Route – Finance then sends them projects that both pass due diligence and match the investment mandate. Multiple investors then contribute a portion of their mandate to each project, which works to minimize risk. The paperwork for each loan is drafted by specialist solicitors, who provide confirmation that the security has been granted in favour of the lenders. All investments carry inherent risks, and returns are never fully guaranteed. However, The Route – Finance’s due diligence processes are designed to expose all risks associated with a project, and independently confirm all written documentation and assumptions that have been used in the financial analyses of borrowers, securities and business plans.