Understanding The Alternatives: A Guide To Alternative Finance Platforms

Alternative finance umbrella termEvery industry and discipline the world over has its own set of jargon that you simply won’t encounter anywhere else. If you’re into poetry, then you will be dealing in the realms of enjambment, villanelles, caesuras, and anapaestic tetrameter. If you’re unfortunate enough to find yourself in the world of law, then it’ll be insolvencies, chattels, RFLs and OFRs. If you’re working in a restaurant kitchen, then you will of course be completely au fait with the differences between mirepoix, julienne, brunoise, paysanne, macedoine, chiffonade and jardinere when it comes to preparing your vegetables.

And now that you’ve come along to learn a little more about alternative finance, you will of course not be surprised to discover that you are going to have to get to grips with the differences between P2P business lending, reward-based crowdfunding, debt-based crowdlending, and a whole lot more besides.

42% Of SMEs Unaware Of Alternative Finance

For some businesses looking to grow, the simple but unfortunate fact is that they are completely unaware that there are alternative finance platforms available to them. Indeed, this is the case for as much as 42% of SMEs, according to recent survey data from UK bond Network.

MerchantMoney.co.uk goes on to note that:

“9% of SMEs who were familiar with at least one form of alternative finance stated not having enough knowledge about alternative finance platforms as the main reason for not using them.”

Indeed, awareness of alternative finance is most definitely on the rise, however, there is still a lot of confusion and misinterpretation of the various terms, titles and general jargon that is associated with the sector. For one thing, there is a huge range of products, services and platforms that all fall under the same umbrella of “alternative finance”. And so, below we have listed the main forms of AltFi platforms that businesses and individuals are most likely to come across and provided explanations for each.

But firstly, perhaps it’s best to start off by answering the most important question of all…

What Is Alternative Finance?

Put very simply, alternative finance describes any financial services that are provided outside of the traditional banking system.

Strictly speaking, anything from pawnshops to passing the collection plate around the congregation on a Sunday could be described as “alternative finance”. But, generally speaking, these days when you hear or read about alternative finance, it will largely be in reference to the large number of internet-based platforms on which borrowing and lending takes place between private individuals and businesses.

There are, of course, many different types of these sorts of platforms, and the most popular of which that you are most likely to encounter we have outlined below.

Alternative Finance Platforms For Business Explained

P2P (Peer-to-peer) Business Lending

P2P lending describes a process whereby cash-rich investors lend their money directly to borrowers, normally via an online P2P lending platform where borrowers and lenders are matched. Both parties benefit from these platforms – lenders achieve higher interest rates than if they had gone through a bank, and borrowers a lower interest rate (typically). Some well-established P2P lending platforms have developed a supply of funds to compensate the lender should the borrower default, however, the risks are still considered to be generally higher for lenders as loans are generally unsecured.

Sophisticated Investor to Business Lending

This describes a type of platform where finance is provided exclusively by closed networks, which usually consist of a syndicate of high net worth, sophisticated investors, collaborating in a formal way to provide funding, either on a debt or equity basis, to businesses only. The Route – Finance is an example of this type of platform.

Crowdfunding/Crowdlending (Four Ways)

Crowdfunding or crowdlending is the practice of raising small amounts of funds from large amounts of people (i.e. a ‘crowd’). Again, using the power of the internet, crowdfunding platforms are often used by entrepreneurs to pitch their business ideas to large groups of people, who, if interested and convinced by the project, have the option to respond by donating a small portion of the total money the borrower needs to reach his/her target.

Much like “alternative finance”, “crowdlending” itself is an umbrella term that can be further broken down into four main types:

Donation-based Crowdfunding

As the name suggests, this is type of crowdfunding describes a process whereby many people simply make donations to a project, i.e. without the expectation of seeing a return. Charity and community based projects are the normal recipients of such funding.

Reward-based Crowdfunding

Reward-based crowdfunding platforms allow a ‘borrower’ to access monetary funds from a crowd of lenders in exchange for non-monetary rewards. For example, musicians trying to raise enough money to record a new studio album might reward their funders with a free copy of the finished record or free tickets to a live show.

Equity-based Crowdfunding

Similar to reward-based crowdfunding, with the difference being that funders receive a share in the company that they are financing in return for their cash.

Debt-based Crowdfunding

Debt-based crowdfunding requires the borrower to repay all monies borrowed. Platforms of this kind will organise the borrowing, lending and repaying of the loan, and will often negotiate the terms of the loan and seek to provide securities for investors should the borrower default.

The Angel Investor

This describes an investor in a business who provides financial backing for startups and SMEs. Usually, angel investors are sought amongst the entrepreneur’s friends and family. The finance that the investor provides is often a one-time cash injection to help the borrower’s business get off the ground or otherwise expand, however sometimes an angel investor will provide ongoing financial support for the SME. Typically, this type of investor will give more favourable terms than other lenders, and will be more focussed on aiding the continued success of the business, rather than on securing high returns from the investment.

Invoice Discounting

This is a situation where businesses borrow money from an alternative lender based on amounts that are due to be paid from the business’s customers. A percentage of the invoice amount is paid to the lender as a fee for borrowing the money. Essentially it’s a scheme where lenders buy an invoice from suppliers at a discount. It’s no secret that there is a critical late payments culture that is having a serious impact on business trading right around the globe – it’s estimated that there is currently as much as $2 trillion (£1.27 trillion) locked up in late payments globally.

Factoring

Another form of invoice financing, factoring is a type of debtor finance, again with the supplier selling its invoices to a third party (i.e. a factor). The factor immediately pays a percentage of the total amount of the invoice (typically between 70% and 85%) to the supplier, and then proceeds to chase the full payment of the invoice on the supplier’s behalf. Once the full amount has been paid, the factor pays the supplier the outstanding balance, minus fees.

Supply Chain Finance (SCF)

SCF is similar to invoice financing, though it is used as a set of B2B solutions to optimise cash flow throughout supply chains. The process begins as soon as a supplier sends an invoice to a buyer. The buyer approves the invoice and sends it on to an SCF provider, who will then sell the invoice to a financer at an attractive rate. As with invoice financing, SCF is designed to counter the late payments culture that can cripple the cash flow of suppliers. For instance, in a supply chain with 60 or 90-day payment terms, it is possible for the supplier to receive payment as early as day 3 or 5 (albeit at a reduced amount), while the buyer is able to hold off payment to the financer until day 60 or 90. It is a win-win situation, reduces risk across the supply chain and unlocks liquidity throughout.

Pension-led Funding

This is a practice whereby business owners can access some or all of their pension funds that they may have accumulated from past or present employment, and use this money as a cash injection for investment. Pensions are transferred into either a self-invested personal pension (SIPP) or a small self-administered scheme (SSAS). Both are pensions that allow the owner, not the insurance company, to make decisions as to where their money is going to be invested.

Final Word

As the awareness of alternative lending platforms like those mentioned above continues to increase, many SMEs who have been rejected by their banks will begin to find the capital that they require for continued growth. The market is clearly there for alternative finance, and hot demand for it. With a whole plethora of platforms outside of traditional banking making funds available to businesses, the goal now for the industry is to continue to raise the profile of what’s on offer, so that more startups and SMEs can survive and the economy continue to recover and grow.

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