Many entrepreneurs find it incredibly easy to come up with fantastic new business ideas. Unfortunately, sourcing money to help finance those million-pound ideas isn’t quite as simple as it used to be.
Although most markets have at long last recovered from the global financial meltdown of 2008, the tremors of that recession have undeniably given way to a new generation of justifiably cautious lenders – which is why traditional small business loans are becoming worryingly scarce.
According to the British Business Bank, loan applications plummeted over the course of 2017, with just 1.7% of smaller businesses even bothering to submit applications. That represents the lowest recorded figure of small and medium sized (SMB) loan applicants since the 2011 launch of BDRC’s small and medium sized enterprises (SME) Finance Monitor.
It’s also a reflection of business confidence in the traditional brick-and-mortar lending system itself. Just 43% of small business owners now exhibit confidence they’ll get a loan when they apply. Yet regardless of waning confidence, firms still need capital to invest and grow – which is why more and more business owners are turning to alternative finance models to fund their SMBs.
In its third European Alternative Finance Industry Report, published at the start of 2018, researchers at the Cambridge Centre for Alternative Finance (CCAF) found that Europe’s online alternative finance market had skyrocketed by 41% in the last year to reach an estimated €7.6bn. As Europe’s biggest market for alternative business finance, the UK made up around 73% of the continent’s total market volume.
The opportunities available for business owners in this thriving new alternative finance market are diverse and far-reaching. But in terms of growth and availability, the most popular up-and-coming finance options for SMBs are peer-to-peer (P2P) lending, invoice trading, asset finance and equity-based crowdfunding.
What is P2P lending?
P2P lending is by no means a new phenomenon, but over the last year it has experienced the largest segment growth of any alternative finance model in Europe. P2P consumer lending now accounts for 34% of all alternative lending, and it’s not hard to see why demand has surged. After all, the concept itself is relatively simple.
P2P lending is a very basic finance model that sees a business borrow money from a group of individual lenders that is subsequently repaid with interest based on a predetermined timescale. In many cases, P2P lending has become a low-risk investment tool in its own right – which is why there has been a wave of new P2P lending platforms pop up over the course of the last 5 years.
Sites like Funding Circle, Zopa, Prosper and Lending Club have generated plenty of headlines in recent years for their success stories in helping to finance noble start-ups that would have otherwise likely gone unfunded. On the flip-side, P2P lending sites are also a no-brainer for individuals looking to invest, with historical returns on most platforms averaging 3-8%.
P2P platforms essentially act as gatekeepers connecting small-time investors with SMBs in need. While the sites aren’t actually lending to businesses, they do generally have underwriting teams responsible for conducting risk assessments for particular projects. As a result, it’s fair to liken P2P lending to unsecured loans.
What is invoice trading?
Invoice trading is a dynamic way for existing businesses to unlock cash from the money in which they are already owed by others – and it is particularly ideal for those businesses with a collection of high-volume invoices from major projects or regular clients.
The process of invoice trading sees a lender purchase a company’s unpaid invoices in exchange for a nominal lending fee. In turn, SMBs can access instant cash and could subsequently end up receiving relative income after customers pay their invoices, less the lender’s fee and amount borrowed.
The market for this type of financing has grown rapidly in the last year, with figures from the CCAF indicating invoice trading generated a total volume of £452m in the UK alone. That represents an annual volume growth of almost 40%, and spike in demand has given way to a range of subcategories within the invoice financing model itself.
Examples include invoice factoring, which is a product in which the lender also provides credit control services to ensure that customers pay their invoices on time. This model is particularly useful for micro-businesses that lack the time and resources to chase late-paying customers, because with invoice factoring collection responsibilities fall on the lender.
An alternate form of invoice finance is discounting. This model is a bit more straight-forward, and sees business owners retain control of their sales ledger, chase clients for payment and then take responsibility for repaying the lender what was borrowed plus their service fee.
What is asset finance?
Asset finance products have been a peripheral feature of the UK’s lending sector for more than four decades. Yet, as interest in traditional loans for SMBs continues to decline, asset finance has re-emerged as an attractive alternative funding model worth exploring.
Asset finance is a funding tool in which cash is extended against a wider pool of assets. That makes asset finance incredibly similar to invoice trading, which sees a lender effectively purchase a company’s debt. In general, the most common types of asset finance relate to equipment, real estate and intangibles like intellectual property.
According to the Asset Based Finance Association (ABFA), there was nearly a 10% increase in lending volume over the course of 2017, and there are various subcategories within this funding model that SMBs have been capitalising on.
One of the most popular types of asset finance is equipment leasing. This funding model has grown rapidly as a consumer finance tool for various expensive household goods, but it has gained phenomenal traction in the business-to-business lending space in recent years. Equipment leasing covers just about any type of major equipment or infrastructural investment, and sees a business rent an asset for a nominal period of that asset’s useful life.
At the end of that leasing period, SMBs can either continue to lease the equipment, agree to purchase it outright for an agreed price, or simply return it to the lender and move on.
Although many business owners are wary of asset finance because of the lack of ownership it entails, it can be incredibly useful for small businesses in terms of tax efficiency. That’s because as a lease-holder, any aspect of a business funded through an asset finance deal doesn’t ordinarily appear on a company’s balance sheet, enabling business owners to offset lease payments against any profit and claim VAT.
Equity crowdfunding is without doubt the most intriguing and fastest-growing source of loans for SMB owners. According to the British Business Bank’s fourth Small Business Finance Markets Report published at the start of 2018, the funding volume extended to small businesses through equity crowdfunding rose by 79% in the first three quarters of 2017 alone.
Everyone will be familiar with the idea of crowdfunding in principle – although the sort of crowdfunding that usually generates big headlines in the media is typically based on donations or rewards.
Equity crowdfunding is different in that every individual receives equity in a business in exchange for their investment. That equity normally takes the shape of one or more shares in a limited company, although certain businesses have been known to show a bit more creative flare in terms of offerings.
Notable equity crowdfunding success stories include the Scottish-based craft brewery BrewDog.
In 2017, BrewDog launched the latest round of a major crowdfunding programme with a view to circumnavigate traditional lenders and rouse its highly engaged consumer base in order to fund a new brewery to fulfil a sharp increase in demand for its beers across the UK and Europe.
Thanks to a formidable and well-branded marketing campaign to coincide with the crowdfunding drive, BrewDog blew its £10m target out of the water. After extending its initial fundraising deadline, the campaign generated more than £22m in funding – enabling the brewer to further invest in its first-ever sour beer facility, a brewery in Asia and a £5m facility in Australia.
The crowdfunding campaign’s rapid success subsequently pushed up the company’s share price, and saw the number of shareholders with equity in BrewDog rise to more than 88,000 individuals.
Equity crowdfunding might not be for everyone. It can be riskier than P2P lending from an investment point-of-view, because investors take a stake in the company, which is riskier and does not include a defined time-period in which a would-be lender could hope to anticipate any sort of return.
Likewise, by engaging in an equity crowdfunding campaign, business owners are effectively handing a small piece of their business over to hundreds, if not thousands, of others – potentially placing a company’s strategic control out of the hands of its owners.
However, equity crowdfunding is a good finance option for SMBs on the hunt to raise money for growth without needing to fulfil arbitrary eligibility requirements for a loan or commit to a tedious repayments schedule.