Traditionally, if you were a small business owner needing to raise finance you would head straight to the bank. This is still the main route for many businesses, with 80% of SME finance still provided by traditional finance institutions, but this option is becoming increasingly difficult for small and medium sized businesses (SMEs) to access.
Since the financial crisis of 2008, many businesses have struggled to secure finance from traditional sources. Around 50% of first time SME borrowers are rejected for a bank loan and SME overdrafts have been cut at a rate of £5 million per day. This lack of bank funding has driven the growth of the alternative finance market as SMEs turn to options such as peer-to-peer (P2P) lending and crowdfunding to source the capital they need.
But with so many providers in the alternative finance market, how do you find one which suits your business? We’ll explore what to consider for the main forms of alternative finance.
Peer-to-peer lending, the largest sector in the alternative finance market, works by investors bidding on loans listed on an online platform and collectively lending money directly to a borrower in return for monthly repayments with interest.
Borrowers must undergo a robust credit assessment process before their loan is accepted, and platforms typically require businesses to have been trading for two years or more with a minimum level of annual turnover. Due to this, peer-to-peer lending is not typically available to startups, but it is a good option for more established SMEs who have been rejected for a bank loan or who need finance urgently and have enough cash flow to make repayments.
The loan assessment process is typically more flexible than that of banks, allowing more businesses to be accepted for loans and peer-to-peer lending offers faster access to finance with the time from applying to receiving a loan being weeks rather than months. The length and amount of loans can vary from around £10,000 for 6 months upwards, so peer-to-peer lending suits businesses looking for different amounts of finance in the medium to long term.
Peer-to-peer lending platform: LendingCrowd
Equity crowdfunding is like peer-to-peer lending in that many individuals come together to invest in a business through an online platform, but instead of receiving loan repayments investors get shares in the company and make money when the company is sold or floated on the stock market at a later date. Equity crowdfunding is ideal for start-ups and early-stage businesses that don’t meet the requirements of a peer-to-peer loan, but need funds to launch a new company, product or other project.
You must be prepared to give up equity in your business in the long term, and as equity crowdfunding carries high risk for investors due to many startups failing, they may want an active role in the day-to-day running of the company. This can be an advantage; some investors may have knowledge of your business sector, and having a group of investors in your company who want it to succeed for personal reasons creates an immediate customer base. One downside of launching an equity crowdfunding campaign is that there is no guarantee that your funding goal will be met, so promotion of your campaign is essential for success.
Equity crowdfunding platform: Seedrs
Reward crowdfunding is a similar model to equity crowdfunding, but investors receive rewards such as an acknowledgement or the company’s products instead of a stake in the business, with rewards increasing in value for more money invested.
As investors are not receiving financial remuneration, reward crowdfunding only works for businesses with a very loyal customer base who are emotionally invested in the business, want to help fund new projects and are interested in receiving your products in return for their investment. This method of alternative finance is only suitable to raise smaller amounts of money than equity crowdfunding or peer-to-peer lending, but your credit rating and how long you’ve been trading do not matter. As with equity crowdfunding, you must be prepared to put a lot of effort into promoting your campaign to be successful.
Reward crowdfunding platform: Kickstarter
Invoice trading is a type of short-term alternative finance involving businesses selling their invoices to a group of investors at a discounted price over an online platform. This allows businesses to get funds almost immediately rather than waiting for their clients to pay them, so it is ideal for businesses needing urgent funds for working capital but not for those looking for larger amounts or long-term finance.
This source of finance is highly flexible – you can upload invoices to be sold as and when you need extra funds, but you are not committed to selling invoices when you don’t need the money. One disadvantage is that selling your invoices may affect your ability to get accepted for loans as you no longer have money owed to you which can be used as security. It is therefore important to consider your future finance plans before going down the invoice trading route.
Invoice trading platform: MarketInvoice
‘Angels’ are wealthy individuals who invest in businesses in return for equity. This type of finance is suitable for early-stage businesses or startups, and angel investors are typically interested in high-growth tech businesses with the potential to give them a high return on their investment in the future. If you want to secure angel investment, you have to pitch your business to gain their interest.
Angel investors will typically have knowledge and experience in different business sectors so they can be a valuable source of input and ongoing guidance to help your business succeed. Gaining angel investment means that you will be giving up shares in your business for the long term, so you must be willing to not have full control over your business.