Since the recession in 2008, there have been many complaints that the banks aren’t lending to SMEs. As a result businesses are increasingly seeking out alternative finance routes to access funding.
What is Alternative Finance?
Alternative finance is any type of business funding that doesn’t come from a traditional institution such as a high street bank. Traditional finance is a good fit for many businesses, but banks often have requirements which smaller businesses can’t meet, forcing them to look for other options. These options include crowdfunding, invoice factoring and discounting, and peer-to-peer business lending.
At its heart, alternative finance is about finding finance more directly, without requiring a large institution to act as a broker.
“There is a growing movement afoot to revolutionise banking, investing and giving by using technology to simplify the links between those who want to invest money and those who need it.”
– Stian Westlake, Executive Director of Policy and Research, Nesta
This post will cover some of the most popular forms of alternative finance available to SMEs, explaining what they are and when you might use them.
One way to raise some cash for your business is by putting your upcoming invoices up for grabs. There are several more traditional providers (including some banks) who offer to buy your invoices for a fee, effectively giving you a percentage of the amount up front. However, there are a number of alternative services that have grown in momentum in recent years. These services allow you to put up your invoices for sale online directly to willing individual lenders.
These alternative services help you sell your invoices more efficiently, quickly and cost effectively than their traditional counterparts. Financing your invoices means you don’t have to take on debt or give away equity or collateral.
Who uses it?
CADA Design Group, an interior design agency, uses an online service called Market Invoice to raise business funds. CADA works with large corporates, which often involves issues with late payment of invoices. Having to wait for payments limited the company’s ability to pitch for new work. Instead of going the traditional loan route or giving up equity, CADA used one of their existing assets: their invoices to raise funding to grow the business. The company receive funds from individuals who choose to invest spare cash in their invoices within 24 hours, which has enabled CADA to grow its team and business.
You’ve probably heard the term ‘crowdfunding’ knocking about all over the place, but what does it really mean?
“Crowdfunding is a way of raising money from a large number of people by asking them to each provide a small part of the total you need.”
– Tim Wright, Founder at TwinTangibles and author of the Scottish Crowdfunding Report
Usually the crowd donates it, gets something in return for it, lends it or buy shares in your organisation. Crowdfunding is in some cases preferable to traditional investment because of the extra benefits available, such as free publicity and not needing to give up collateral or get into debt.
Crowdfunding can give you a platform and mechanism to access your own audience, taking a lot of the pain out of asking for and collecting cash. It can also give you access to new groups of people who want to provide capital. It’s not easy, it’s very public, but it is becoming increasingly popular.
There are several types of crowdfunding that we’ll cover: equity, reward-based and donation-based.
With equity crowdfunding, funders receive shares in exchange for capital. With this type of funding, no collateral or debt is required, but you do need to give away a part of your business in exchange.
With reward-based crowdfunding, funders receive a reward or the product itself. Similarly with this option no collateral is required, and neither is equity in your company.
Donation-based crowdfunding is used by nonprofits, educational bodies and charities to raise funds. With this option funders don’t receive anything in return — apart from the knowledge that they’ve helped you out!
Who uses it?
A famous example of a successful crowdfunding campaign is a notoriously NSFW card game called Cards Against Humanity. Billed as the ‘party game for horrible people’, the makers of Cards Against Humanity used a platform called Kickstarter to raise $4,000 in two months to print their game in exchange for a free copy. By the end of the campaign, the team reached $15,570 – 389% of their original goal. Today Cards Against Humanity is a best selling game on Amazon.com.
Peer to Peer Business Lending
If you choose to go with peer to peer (P2P) business lending, you will receive a loan that comes from a group of individuals who put their own cash up to be lent. In return, they receive interest on their investment. This interest tends to be much lower than what you would be charged by a financial institution. The lending is carried out through a platform, and loans can range from £5,000 to £1 million over months or years. In return you will have to make a fixed monthly payment and you will be charged fees of 2-5%.
In the old days, you’d go to an institution and your case would be considered either by an individual at a relationship bank such as this one, or a system that doesn’t always allow you to explain the context of your request.
With P2P lending you are able to make your case to hundreds or thousands of individuals. Each individual weighs up the opportunity you are offering, assessing the risk and attaching a cost to that risk.
Who uses it?
In the early 2000s, Cathy Olmedillas spotted a gap in the market and started an independent children’s publishing house that encourages imaginative thinking and creativity called The Anorak Press. Over the course of 10 years, the business grew and began to publish two magazines and a series of videos for its YouTube channel. To grow the business further, Cathy needed to employ permanent staff. In order to achieve that goal, Cathy borrowed £25,000 through a service called Funding Circle. By using this form of alternative funding, Cathy saved money she would have spent on fees from a traditional bank loan.
How to know when you need to bridge a cash gap
Are you looking to forecast when you might need a cash injection? Check out Float Cash Flow Forecasting!
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