The growing popularity and availability of ‘alternative finance’ has been one of the big business stories of the last five years or so.
The expansion of the Alternative Finance universe isn’t surprising. The great financial crisis swept away many of the comfortable ‘certainties’ of the funding marketplace. Prior to the meltdown in the global banking system, even first-time entrepreneurs found that debt funding – even if only in the form of overdrafts – was easy to come by and relatively cheap. Arguably, broad confidence in the economic outlook for the UK and Europe also encouraged equity investment. After the crisis, the landscape changed. As banks rebuilt their balance sheets, money became harder to come by.
Alternative Finance stepped in to fill the vacuum, providing businesses with a means to borrow or sell shares via online platforms. Thanks to platform technology and a ‘crowdsourcing’ model, money became available that wasn’t there before.
And the sums are significant. According to research company Bond Mason, £3.2bn was lent to investors through peer to peer platforms in 2016. Crowdfunding also continues to flourish, with investment intelligence company, Beauhurst putting total investment in the first half of 2017 at £98m.
The Bigger Picture
But if the Alternative Finance marketplace has established itself as an ever more popular option for businesses in search of funds, it is also home to a diverse and potentially confusing collection of business models. Any business seeking to raise money through AltFi, needs to understand the main models and what they offer. Here is a short guide to what is available.
The Old School – Invoice Discounting and Asset-Based Lending
Long before the financial crisis, Invoice Discounting, Factoring and Asset-Based Lending (ABL) offered an alternative to term loans and overdrafts.
In the case of Invoice Discounting and Factoring, businesses borrow against the value of the debtor book, month by month. For their part, ABL lenders facilitate borrowing against assets such as property or machinery.
Invoice and ABL lending are offered by High Street Banks and are perhaps no longer ‘alternative.’ However, there are many specialist lenders offering service models that are distinct from that of the banks.
Invoice Trading is a platform-based variation on the invoice discounting theme. As with conventional invoice finance, the company borrows against the value of a bill sent to a client. However, in the case of Invoice Trading, the business joins a platform and can essentially ‘sell’ individual invoices to a community of lenders. On an invoice-by-invoice basis, the company can choose the best deal.
Of the new, platform based models, peer to peer is the most widely used form of Alternative Finance. You can see it as a subset of the sharing economy in which underused assets – in this case money – are put to work.
Individuals with cash sitting in bank accounts, earning low interest rates, can instead lend (via a platform) to businesses or individuals. Although the cash is then tied up for an agreed term, the returns are higher than those offered by bank savings accounts.
Initially, the peer-to-peer lending community was made up – at least to a degree – by ordinary savers seeking better returns. Today, however, platforms also attract institutional investors and some High Net Worth (HNW) individuals.
Private Debt Platforms
A generalist peer-to-peer platform may not cater for the needs of High Net Worth investors. As the Alternative Finance marketplace has evolved, services have been developed that are aimed directly at HNWs and sophisticated investors.
The Route – Finance’s Private Debt Platform was set up to give HNWs opportunities to secure superior returns from selected business lending opportunities. In particular, The Route – Finance focuses on special situations where companies require funds relatively quickly to address challenges, problems or opportunities (£0.5M-£5M). The returns reflect the ‘risks’ associated with special situations. However, risk is mitigated by comprehensive due diligence.
Here in the UK, much of the media coverage of crowdfunding has focused on platforms enabling businesses to sell shares to extended groups of shareholders – namely the ‘crowd.’
But that’s by no means the only model. Rewards or donation-based crowdfunding sites were originally established to enable inventors or creative people to pitch ideas to the ‘crowd.’ If an idea captured the imagination of a potential funder, he or she would pledge cash in return for a reward.
That reward might mean a namecheck on the credits of a film or CD, or first sight of a product.
Crowdfunding is still used to pre-fund projects such as films and books, but increasingly sites such as Kickstarter and IndieGoGo are seen as useful ways to sell products direct to potential buyers, with the money raised on a campaign going to fund production. It’s a no risk way of assessing demand, securing sales and creating an online buzz.
The UK’s first equity crowdfunding site – Crowdcube – was established to allow ‘armchair dragons’ to buy stakes in small companies for as little as £10. The small investors still exist, but today they are often sitting alongside High Net Worth individuals, and VCs. As such, it is now possible to raise several million pounds through an equity crowdfunding platforms. Indeed, some platforms, such as the Syndicate Room, ensure that professional investors take the lead in backing businesses, with small investors coming in behind them. Today, this type of crowdfunding can take the place of a seed round or even a series A.
A Deeper Dive
It’s important to remember that even within these broad categories, providers may running subtly or very different business models.
To help businesses and brokers find their way through the maze, The Route – Finance has compiled the Guide to Alternative Finance 2017, which can be downloaded here. It contains not only an overview of what’s available but also profiles of the major providers and their market positioning.