We look at the different types of alternative finance and how they can help your business.
If your business is thinking about raising finance in the next few months, there’s something you should know.
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.
Heard of ‘alternative finance’?
Alternative to what, exactly? The banks.
It’s a bit of a buzzword, granted. But it is something Vince Cable has been championing recently, adding gravitas to this emerging sector. At a recent conference, Cable 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”.
His 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 providers 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.
You might have heard of invoice finance, factoring or invoice discounting- but this is different.
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.
The consequence? The finance can be provided more cheaply and quickly than by traditional providers.
Invoice trading is massively different to what’s gone before:
- No contracts. That means no ‘setup fees’ or ‘termination fees’, unlike factoring.
- It’s pay-as-you-go, so the business is in control of how many invoices they sell.
- It’s easy to apply, and everything’s done online.
- Funds can be in your account on the same day.
- In the vast majority of cases there are no debentures or personal guarantees.
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.
The second big new type of finance for businesses? So-called ‘peer-to- peer’ loans.
This product 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:
- A quick, online application process without seeing any bank managers
- Less time until the finance is drawn down
- Businesses know exactly what they’ll have to pay and how long it will take them to pay back the loan
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.
Providers of this type of loan include Funding Circle and ThinCats, 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’ (http://www.p2pfinanceassociation.org.uk/members). Their strict guidelines mean members must adhere to certain codes of conduct.
The third 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.
So now you know about the new and exciting types of alternative finance that are currently available to UK businesses.
Which will you be using?