New kids on the block

The world of alternative finance, where the traditional intermediary such as a bank is bypassed, is quickly gaining traction. The effects of the credit crunch and dissatisfaction with the offerings of traditional financial institutions have served to accelerate it. This year it’s expected that almost £250m of UK lending will be facilitated through alternative funding platforms [1]. Its growing prominence has led the Bank of England to suggest that over the next decade the area could become a major force in the financial market [2].

It has garnered a reputation as the new kid on the finance block but has actually existed in some form for almost a decade. One of the big UK companies Zopa, was founded in 2005. It’s an industry with momentum but what exactly are alternative finance platforms?

Alternative Finance Platforms

The marketplace is becoming crowded with an increasing number of platforms. Peer to peer (P2P), peer to business (P2B), social finance, disruptive finance, democratic finance and crowdfunding are just some of the terms used to describe the various different types of alternative finance. The commonality is that they bring together those looking to lend money and those looking for funding through an internet platform, which acts as the facilitator. In return it takes a commission from one or both of the lender and borrower (typically around 1% but can be up to 10%) and/or fee.

Financing Models

There are various different models that categorise the platform offerings. Some are with the aim of a financial return, others are reward or donation based. Each will have its own risk profile.

• Equity financing gains a stake in a company in return for capital. Generally this type is utilised by start-up and early stage companies, who are considered at the higher end of the risk spectrum and who often don’t have access to other financing arrangements or the immediate ability to service loan repayments.
• Debt financing is where the business is loaned money and arranges to pay it back with an agreed rate of interest over a period of time. Most platforms provide this to established businesses with at least 2 years of trading history and in good financial health.
• Asset
  financing involves investing money into an asset, such as machinery or a property, and offers a form of secured lending for lenders looking to reduce their risk exposure.
• Other financing variants also exist and include reward financing, where the return may be a product or privileged access to a company offering, and invoice factoring – where it is possible to bid on outstanding invoices in order to provide a cash advance to the respective company who has issued the invoice and receive the return value of the invoice and an addition fee.

The matrix below summarises some of the different UK platform operators and their offerings.

Crowdfunding: Too crowded?

The table shows there are a large number of platforms and with the exception of Zopa, all of whom emerged in the last three years. What is apparent is they are not all competing for the same segment of the market and the differing models currently allow room for many to exist. Whether there will be market consolidation further down the line or market players will expand the range of models offered remains to be seen. Given the infancy, it's also too early to say whether this will become a mainstay solution to SME funding. However, with the continuing dissatisfaction with traditional financial institution's offerings, there will be more scope for market growth.

Sources

[1] - NESTA Crowdfunding Report

[2] - Crowdfunding could revolutionise lending says Bank of England