Over the last five years a new breed of business finance has emerged. The Internet has enabled new, innovative ways to connect borrowers and investors, and the result is that there is now a whole ream of options for businesses looking to finance growth.
Alternative to what, exactly? The banks.
It’s a bit of a buzzword, granted. But it is something that the Government has been championing recently, adding gravitas to this emerging sector. At a recent conference in 2015, Vince Cable (then Secretary of State for Business, Innovation and Skills) said that, “The most important single factor which is going to make recovery from this profound crisis difficult is the current access to finance for growing companies”.
The Government's British Business Bank initiative has also put its money where its mouth is, lending around £300m through alternative finance companies.
“Flexible finance for companies in technology and media”
These new finance providers aren’t as rigid as the banks - they’re much more flexible about who they will lend to.
There are some business models that the banks just don’t understand. Traditional banks look for businesses with solid assets that they can secure a loan against, such as property or machinery. Software houses, design agencies, media companies - these are just three examples of sectors which typically don’t have these types of security.
All too often, without the weight of tangible assets on the balance sheet, the credit scoring algorithms used by the banks spit out an automatic rejection: a case of, ‘computer says no’.
The alternative business lenders are much more flexible. Being online businesses themselves, there is generally a much better understanding of these new sectors. Many of the borrowers on these websites fall into this category - they would have been unable to access the funding they need from a bank.
So here are the three main types of alternative finance you need to know about.
Peer to peer finance (peer-to-peer or P2P) works in a similar way to the ‘invoice trading’ platforms, with businesses needing finance on one side, and investors who lend money on the other. The finance provider simply provides a website and credit-checking service that connects the two communities.
In practice, businesses can access a term loan without going through their bank. That means:
Remember, unlike your bank, an alternative finance provider should be able to process your entire application online and over the phone. They’ll be available to chat if you need help and, unlike your bank, won’t keep you on hold for hours.
P2P finance companies include Funding Circle and RateSetter, although there are many new names also popping up as the sector grows.
If you’re unsure which companies to trust, a good guide is to stick to members of the trade body, the ‘Peer-to-Peer Finance Association’, a list of which you can find here. Their strict guidelines mean P2P finance company members must adhere to certain codes of conduct.
The second category we’ll look at is perhaps one that you’ve heard of.
Crowdfunding is a word that has recently been added to the dictionary, and you might have seen it crop up a few times in the press. In terms of alternative finance, crowdfunding usually refers to equity finance, raised online from a pool of investors.
Providers that offer this type of finance normally vet the businesses applying and choose the most promising looking business plans to feature on their platform. Investors then have an opportunity to invest for a small chunk of equity, and they diversify their risk by investing in a range of businesses at the same time.
Providers of this type of equity finance include Crowdcube and Seedrs.
Invoice trading platforms provide finance for businesses against individual invoices, rather than signing clients up for long term contracts. It’s called ‘invoice trading’ because it connects businesses selling invoices with investors lending against those invoices via an online ‘peer-to- peer’ network.
This means the finance can be provided more cheaply and quickly than by traditional providers.
Invoice trading is different to what’s gone before:
For B2B businesses, waiting for clients to pay large invoices can make cashflow a nightmare. This new type of invoice finance can really help smooth out cashflow in a flexible way.
You can find out more about invoice trading here.