Alternative funding, peer-to-peer (P2P) lending, crowdfunding. Call it what you will but it’s nothing new. According to the UK Crowdfunding Association its roots lie, like many things, in music.
It was British rock group Marillion who kicked the process off when, in 1997, they needed $60,000 to fund a US tour. The first online platform appeared in 2001 and hundreds more as well as specialised firms are available now funding all manner of projects, startups and investment opportunities.
Today, compared with the financial meltdown witnessed 10 years ago, we have a stronger economy despite the risks that Brexit poses. Yet now, with bank lending up, the alternative platforms are being brought into line. They have been told to get their governance and transparency in order following a number of high-profile investment project failures.
What is alternative funding?
Alternative funding is best described as the range of options available to both consumers and business owners outside of a traditional bank loan. A market that has sprung up to fill the voids left by banks, it involves many-to-one crowd-based lending, business angels (high net-worth individuals) offering funding, venture capitalists, and even financial speed-dating where SMEs pitch in three-minute bursts to up to 30 investors in one day. Of particular interest to print is what Mark Nelson, director at Compass Business Finance, terms as equity release in relation to existing assets.
But has alternative funding stood the test of time? Have the banks changed course?
Peter Baeck, head of the alternative finance team at innovation foundation Nesta, considers alternative finance very relevant to SMEs. “We don’t have updated numbers for 2016/17 but models such as those offering funding based on debt and equity have experienced significant growth. They have also, in many ways, become part of mainstream finance. For example, in 2015 they made up more than 10% of loans to SMEs and more than 16% of all start-up investment.”
Roger Aust, managing director of the print division at Close Brothers Asset Finance, has also seen huge growth in alternative lending – and the numbers are spectacular. “In 2016 asset finance and leasing specialists provided £30bn of finance to businesses and the public sector, representing almost a third of UK investment in machinery, equipment and purchased software in the UK last year.” And those numbers are continuing to increase, month on month. Aust’s figures show that asset finance new business “grew by 5% in March 2017 over the same month in 2016”. Despite these figures, Aust considers that the banks are still relevant – “they will always have a part to play; it’s just the market that has diversified”.
The banks are still lending but…
Conrad Ford, chief executive of Funding Options, an online marketplace for SME finance, believes that the banks are more open to lending now.
He says: “Though high-street banks undoubtedly pulled back from business lending in the aftermath of the global finance crisis, they’re now very much back in the market.” However, he’s observed that bank lending policies are showing little sign of the excesses that we saw running up to the global financial crisis – “you could say these are Goldilocks conditions, where supply is not too hot and not too cold”.
That said, the banks, suggests Ford, aren’t helping much with overdrafts because “new global rules designed to make banks more stable have made it unattractive to give overdrafts to SME customers”. From his point of view the strain on working capital is here to stay, and so alternatives to overdrafts, such as invoice finance, will only grow in importance.
What is particularly interesting to Ford is that many firms seem to have learned a lesson from the credit crunch experience of not being overly dependent on high-street banks – “they’ve chosen to keep relationships with alternative lenders open despite being more expensive than traditional bank lending”.
Nelson agrees. He says that the finance market as a whole is trading well, but is very aware of the issues from the credit crunch. “We are providing more and more funding to the UK print market every year,” he says, “which proves that the specialist finance companies are still in demand due to their knowledge of both the print and finance markets.”
Using alternative finance
Alternative finance is a new concept to many and so the natural question is to ask what it can be used for? The answer, not unsurprisingly, from those in the market, is almost anything.
“For example,” says Baeck, “rewards based crowdfunding is great for financing a first product or prototype. Debt-based models, such as P2P lending, are often used by SMEs to buy equipment, from tools to vehicles or the refurbishment of premises. Equity crowdfunding, on the other hand, is most frequently used for investment in startups and early stage companies.”
The wonder of alternative finance for Aust is that funders want to understand the workings of individual businesses: “They use this understanding to provide the correct finance over the correct period, maximising the return on any potential investment.”
Funding can be for new or used equipment, M&A, and to assist cashflow with new projects. Specialist lenders appreciate the true value that exist in assets – new and old – and the wealth they can create for the business.
One of the main strengths of this market is that funding is still available where traditional forms of finance and support from a customer’s incumbent bank are not. It’s because of this that Nelson says that this form of funding is very fluid. He says: “A number of the facilities we’ve recently put in place are to cover restrictions imposed on credit terms by suppliers as their credit insurance levels have fallen.”
He says that companies need the flexibility offered by alternative finance options as raw materials to trade are still required no matter what suppliers demand.
Because the UK has literally hundreds of specialist business finance providers other than the banks, Ford notes that “generally, the more niche the funding need – whether it’s an unusual piece of imported equipment, or a rare situation such as a management buy-in – the more likely that alternative finance will be used. The difficult thing is knowing where to find it”.
Standing the test of time
Will alternative funding be a fad? From Aust’s point of view the phrase “alternative funding” is a misnomer “because Close Brothers Asset Finance has been taking a fundamentally different approach to the rest of the market for over 30 years”.
He reckons that this understanding of sectors has enabled company lending to “continue unabated and unaffected during even the most arduous business cycle.”
Clearly alternative funding, no matter how it’s viewed, is not going away and Nelson says that in terms of longevity, equity release has lasted well. His reasoning is based on experience: “With our knowledge of the print market and the equipment within that market, we are able to lend against the value of the equipment to release cash back into the company.” He sees it as a simple way for firms to restructure any existing debt, to either reduce monthly commitments, or keep ongoing commitments under control when a new investment is being made.
Ford thinks it hard to know which alternative funding options will last as we haven’t been through a full economic cycle. He adds: “It’s easy to forget that these are exceptionally benign times for the UK economy, with the lowest ever interest rate and the highest ever employment rate.” He notes, though, that in determining the success of alternative lending it has to be remembered that it is typically backed by less physical collateral such as machinery or premises; lenders may be more exposed to bad debts if economic conditions quickly change.
The real test is whether alternative funding manages to demonstrate value to those who lend, invest and donate as well as those who fundraise. And Baeck thinks that it has, especially so with debt based models.
Comparing the risks
It’s important to remember that with any form of commercial finance that it is lightly unregulated. Ford stresses that companies are expected to read contracts and won’t have the financial protections given to consumers. His advice is to “take time to understand what smaller lenders are committing you to, as – unlike the major high street banks – they don’t have reputations to uphold with policy-makers and the press.” Personal guarantees are very much in play here just as they are with the banks.
While Nelson echoes the contractual points made by Ford, he cautions firms to understand that some parts of the market can be very expensive, “so it is worth working with a company that has a strong understanding of the facilities available.” This is a perspective that Baeck suggests too. He sees low risks for lenders of borrowers defaulting (but the risks are there compared to other forms of investment). He too says it helps to find established lenders “that have a specific understanding of industries and sectors and their specific borrowing needs. P2P platforms may not fit in exactly with these.”
But among the many positives in alternative finance’s favour there is one worth pointing out and it’s one espoused by Aust – the removal of the threat to a whole business in the case of default. “Most people would perceive lending dangers as putting the whole business at risk. The great benefit of alternative funding options is that it can be asset specific, tailored to future production and very flexible in the event there is a change of direction in the business.” In other words, a failure to pay means losing an asset and not the whole company.
Aust sums up the case for alternative funding well – that it isn’t an elixir or cure-all: “If a business cannot generate the funds to create the investment it needs, then it brings into question the whole basis of the commercial viability of the enterprise.”