Catalyst's guide to the alternative finance market - part 4

Finding the right Alternative Finance for your business

In part 1 of this article we noted various new forms of Alternative Finance have become available to UK SME’s over recent years. In parts 2 and 3 we summarised the main options which now exist beyond traditional sources – i.e. bank lending and whole turnover invoice finance.

To make the right choices for your business you need to understand the main advantages of the options available and to be aware of the potential pitfalls to look out for. We hope this guide will make you aware of some of the right questions to ask before you make your mind up.

Note that different providers within each field may operate slightly different rules so do try and get as much specific information as possible before you commit.

Advantages, disadvantages and costs – a brief summary.

Crowd Funding

Crowd funding sites offer a platform to sell a part of your business in return for cash to get started or to grow.

Key advantages:
No ongoing cost for the money you raise (i.e. no interest)
No need to be trading - can raise money on the strength of a really exciting, well presented proposition.
Trading businesses with a good plan for growth can raise money even if the business has little net worth.
No personal security required.

What to be aware of:
A lot of effort needed to prepare a high quality pitch - can take time, money and personal resources.
“Ordinary” businesses may not succeed – investors often prefer something special, with high growth potential.
There has to be an exit plan – sale of the business or similar – normally in 3 to 5 years.
No interest charges but you are giving away part of your business so price may be very high on a sale.
In most cases there is an “all or nothing” restriction. You must reach the investment target you set or get nothing.

Costs:
Typically an administration fee (£2k to £3k, non-refundable and usually up-front) plus 5% deducted from the money raised.

Peer to Peer Lending (P2P)

Peer to peer lenders offer a platform for you to advertise a loan at an agreed interest rate

Key advantages:
You retain ownership of your business.
Interest rates can be comparatively low depending on how secure lenders feel.
Once set, the interest rate remains for the term of the loan.
Interest only options exist, with repayment over a shorter period at the end or a single repayment balloon.
Loans are typically for 2 to 5 years.

What to be aware of:
Comprehensive document required with detailed information about the business and forecasts of cash and profitability. Considerable input required from owner.
Poor trading history is likely to result in rejection.
Security normally required from the business as well as the business owner.
An intermediary or sponsor manages the process. You are dependant on them managing the process on your behalf.
Little relationship with the actual lenders so hard to communicate if problems arise.

Costs:
Arrangement fee normally 5% of funds raised. Interest typically 10% to 15% per annum plus monitoring fee of 0.5% to 1%. Instalments paid quarterly.

Invoice Trading Platforms

Invoice trading platforms allow you to raise money by offering for sale an invoice which you have raised to your client for goods or services delivered.

Key advantages:
Accelerates receipt of cash already due to the business.
Once registered, the process can be quick with modest input of time and business resource.
Headline rates are low (but caution below)
No long term contract

What to be aware of:
No relationship with lender so no help available beyond amount bid on an invoice
No certainty of cash availability until bid process completed and no long term certainty of cash availability.
Invoices must normally be to very high quality debtors.
The business relationship between you and your customer is in the public domain, potentially visible to competitors.
Some sectors excluded and minimum trading periods and other criteria apply.
Business assets and personal security usually required to support advances.
Costs are not fully transparent – may be more than you expect.

Costs:
Headline rates are typically 1% arrangement fee for the platform plus 1% per month for the lender. Less than 100% invoice is available and you may just require a small percentage. So two important questions to ask:
• -does the percentage apply to the invoice value or the amount advanced?
• -if invoice is paid after (say) 32 days do two months charges apply?

Selective Invoice Finance

Selective invoice finance allows you to draw cash against some or all of the invoices you have raised to some or all of your customers.

Key advantages:
Accelerates receipt of cash already due to the business.
Based on relationships and sensitivity to business need.
All sectors potentially qualify and no minimum trading requirements.
Quick decision making and immediate access to cash.
Pre-agreed facility limits provide certainty of ongoing cash availability.
Can be operated on a confidential basis
No contracts and no minimums applied
Complete transparency on cost (borrower controls and no surprises)
Available to single debtor companies.

What to be aware of:
Aimed at short term funding so expensive for longer term borrowing needs.
Client audit process is quick but thorough (but generally no special preparation needed).
Company security and personal guarantees required to support advances.
Lender likely to require ongoing access to financial information.

Costs:
No arrangement fees or other fixed or minimum charges apply. No admin costs. Pre-agreed percentage of the actual balance advanced is calculated daily. Borrower controls cost by drawing money on the day required and repaying at any time from other sources if available.

Conclusion

No one solution is right for all situations. In this article we have tried to give an insight into the main features of different alternative finance options and what to look out for which could cause problems.

There are a large and growing number of options already available with new variations springing up all the time. In this environment there are inevitably good and bad providers so it’s important to find out as much as you can before you commit.

In deciding which type of finance is best for your situation, ask yourself some key questions:
• 1) Is my requirement long or short term?
• 2) Do I want certainty that the cash I need to run my business is available when I need it?
• 3) Does it matter if my customers know I’m raising money against their invoice?
• 4) Would I prefer have someone I can trust to talk to about my finance needs or do I prefer technology to work for me?
• 5) Can I be absolutely clear about my costs before I start?
• 6) Would I benefit from paying only for the cash I need when I need it?

Finally, most funders will be happy to provide you with the names of some of their existing clients. Use this to make sure that what you are being told is how things work in practice. Get as many names as you can and make direct contact.

A little research now can save you time, money and heartache for years to come!

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

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

Making choices

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Catalyst's guide to the alternative finance market - part 3

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