Many small businesses are continuing to hit a brick wall when sourcing investment or working capital from the traditional lending market. While problems with the banks frequently hit the headlines, one potential solution – at least so far as small organisations are concerned – receives much less attention. It goes under the umbrella term, ‘alternative lending’.
It includes a whole host of arrangements from businesses and individuals borrowing small amounts of money from large numbers of people; through to socially driven startups reaching out for community funding. You may have heard of crowdfunding for instance, – but how much do you know about peer-to-peer lending platforms? What do these platforms involve and do they represent genuine opportunities for SMEs?
Alternative lending: why is it catching on?
Shrinking order books, weakened collateral and a sudden atmosphere of risk aversion in the financial world: in a nutshell, this was the ‘perfect storm’ faced by small businesses seeking finance in the aftermath of the 2008 banking crash. Fast forward to the present and the natural assumption may be that the situation should be much better. After all, order books are filling up, the commercial property market is buoyant and policymakers frequently talk-up their desire to get banks lending again. Not so, it seems – with figures suggesting lending levels fell last year.
Given the climate, it’s no coincidence that the alternative finance market is expanding rapidly. A report from Nesta and the University of Cambridge suggested that the value of the UK market as at the end of 2014 stood at £1.74 billion. It grew by 161 per cent in the year 2013 to 2014 and 150 per cent the year previously and new online platforms are continuing to spring up.
P2P lending, invoice trading and equity crowdfunding are the three most commonly used methods of alternative lending for UK SMEs – yet awareness is still low. For instance, 76 per cent of SMEs were unfamiliar with the P2P model despite this being enjoyed by a lion’s share of the market.
For those still in the dark, here are the key characteristics of these three main models:
P2P Business Lending
These are transactions whereby business owners borrow money from existing businesses (mostly other SMEs) so that multiple lenders contribute to the loan. Examples of arrangers who match borrowers with lenders include Wellesley & Co, Funding Circle and Zopa.
- The Nesta study valued the UK P2P business lending market at £749 million last year
- The average P2P business loan size is £73,222 and it takes an average of 796 lenders to finance a full loan.
- The ultimate decision to lend rests with the individual borrower – although businesses can expect to undergo a vetting procedure by the arranger. Typically, this involves scrutiny of the firm’s up-to-date management accounts, including details of other loans and financial commitments.
- Repayment periods are typically three to five years.
- Interest rates are fixed for the loan duration but vary widely. Rates are generally based on the risk profile of the borrower and the level of security provided. The more company information available, the greater the prospects of acceptance – and of securing a lower interest rate. As such, subjecting your accounts to a health check by a professional covered by professional indemnity insurance for accountants is desirable – as is independent financial advice before you enter into this – or indeed, any other alternative finance arrangement.
This is the process whereby firms sell one or a bundle of invoices at a discount to a pool of investors. Rather than waiting for the invoices to be paid, businesses get an immediate injection of funds from the lenders. UK Arrangers include Platform Black and MarketInvoice.
- According to Nesta, the UK invoice trading market grew by 179 per cent in 2014 to £270 million. The average amount raised per transaction was £56,075. The vast majority of businesses selling invoices had fewer than 50 employees.
- It can be a quick and effective way of boosting working capital; invoice auctions typically take eight hours to complete.
- The downside is that businesses have to stomach the idea of receiving an amount typically between 75 and 85 per cent of the face value of each invoice.
Used mostly by early-stage businesses seeking seed or expansion capital and strongly associated with tech startups, this is where a stake in a business is sold to multiple investors in return for capital. The model received headline attention recently when Boris Johnson announced a £25 million injection of public money into a public/private co-investment fund involving the Crowdcube platform.
- Nesta figures suggest the UK equity crowdfunding market grew from £28 million to £84 million between 2013 and 2014. The average deal size is just under £200,000 and it takes, on average, 125 investors to fund an equity deal.
- As well as a means of injecting capital into the business, involvement can also be a useful way of raising the profile of a new brand.
- A professional pitch, a proven track record and a sound business plan are crucial to securing investor interest.
- On top of the purely financial, some investors can provide a degree of mentorship and access to new market opportunities. The flipside is a loss of absolute control over the decision making process. This could be through the issuing of shares that carry voting rights and/or board participation rights. The terms of the investor agreement need to be tightly defined and understood thoroughly by all parties from the outset.
Innovation and a very real business need have both contributed to the emergence and growth of these platforms. Whether they are right for you will depend on a number of factors – not least the stage your business is currently at and your attitude towards multi-party involvement in your firm. What they show though is that a refusal from traditional lender in 2015 does not necessarily mean your search for capital is over.