Catalyst's guide to the alternative finance market - part 2

Making choices

In part 1 of this article we noted that various new forms of Alternative Finance have become available to UK SMEs over recent years.

Until recently, a business owner or manager looking for cash to help expand or just to run his business really only had two places to go – a high street bank or one of the traditional debt finance providers all offering essentially the same “whole turnover” product.

With choice comes confusion!

Given that there is now a plethora of choice, it is really important that businesses are not only aware of what is available but also have the information they need to make sure they pick the right type of finance for their situation.

Unfortunately, when it comes to making that choice smoke and mirrors are the order of the day – complexity is the salesman’s friend! So in this short series of articles, our aim is to help find a way through the fog.

So what’s out there?

The range of new (broadly defined as “alternative”) finance products now available can essentially be narrowed down to four:
1. Crowd funding
2. Peer to peer lending
3. Invoice trading platforms
4. Selective invoice finance
In this post and the next I will explain the key characteristics of each of these. In the articles which follow we will be looking more closely at what is good and bad about each, pitfalls to be aware of and try to avoid and importantly we’ll be looking at cost.

Crowd Funding

As with all peer to peer finance, the aim is to attract multiple small investors. A business plan is posted on the platform which tries to attract sufficient small investors to generate the whole amount required by the business. There is often an “all or nothing” condition so that if less than the whole amount sought is offered then the business receives nothing.

It is important to understand that if you are successful at obtaining money through one of these platforms you will be giving your new investors a share of your business – it is not a loan and you cannot normally repay the money other than through the sale of the business.

Your new investors will have certain rights, for instance to receive information such as your annual accounts and you will need to keep them informed of how the business is progressing.

There are two types of crowd funding and the expectations of investors vary according to which they are looking at.

The first is “special interest” funding which is often used in the entertainment industry, for instance to pay a musician to produce a new album or to cover the production costs of a new show. In this case, the investor does not normally expect a commercial return on their investment but will have some special rights, such as pre-release copies of a CD or cheap tickets to see a show.

The other type of funding is more akin to angel funding where the investor expects an annual return in the form of a dividend and hopes to make a gain on the future sale of the business.

Crowd funding is only available through web based platforms.

Peer to Peer Lending (P2P)

P2P lending operates in a similar way to crowd funding, in that the lending proposition is posted onto a web portal. The aim is to attract numerous small investors willing to lend their money to the business.

The key difference between P2P lending and crowd funding is that if you are successful your business will receive a loan, not investment. This means that you will have to pay interest on the loan (typically quarterly) and there will be an agreed term over which you have to repay the money borrowed.

In order to attract lenders the lending proposition needs to demonstrate that there is a strong likelihood of both the interest and the capital borrowed will be repaid on the agreed terms. In addition, security will need to be offered, normally in the form of a charge over company assets (a debenture) and a personal guarantee.

Failure to meet the repayments may result in penalties such as a demand for immediate repayment and potentially an increased rate of interest if the loan remains in default. The platform provider acts as middle man between lender and borrower and so will ultimately enforce whatever security has been taken on behalf of the individual lenders.

Provided a loan has been properly serviced and there is adequate security available, it is often possible to return to the P2P lender for a second or later round of borrowing but each new lend has to be separately posted to the platform and must justify why the new lending is required.

As with crowd funding, P2P lending is only available from web based platforms.

Invoice Trading Platforms and our own sector of Selective Invoice Finance will be explained in my next post – so check back soon.

Jeremy Lawrence is the Founder Director of Catalyst Finance

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Catalyst's guide to the alternative finance market - part 1

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