According to turnaround expert Mike Smith from Jamieson Smith & Co the alternative finance market has stepped in to fill gaps left by banks. In this overview of providers, he suggests that may not be such a bad thing.
Whether you want simple banking facilities or to raise funds from invoices, securing finance is changing. Who are driving these changes and which areas are they best suited for?
Recent FSB research found many business owners are now younger and better educated than previous generations. This group is starting to affect on the way finance is raised for small to medium sized businesses.
Without the same allegiances to traditional banking and sources of finance, they are using the internet to find potential lenders.
Recent research revealed that 73% of the clients of Funding Circle, the largest alternative lenders, would not go back to using a bank even when offered the same facilities. Moreover, the government is circulating a consultation paper examining the possibility that banks may be forced to recommend alternative lending options.
As an accountant it is important for you to know why this is happening. The FSB research highlighted that accountants are still seen as the key source of business advice when considering company finances.
This article discusses some of the main options, and where they might fit with a business’s needs.
Alternative invoice finance
Invoice discounting and factoring have been around for a while and are becoming more mainstream sources of finance. But with only around 43,000 businesses currently using some kind of invoice finance there’s plenty of scope for growth.
The online exchange Market Invoice has established itself as a leading player in invoice finance, with more than £168bn in invoices traded to date. It provides a platform for business owners to register their invoices, where they can set terms for potential investors to bid on a particular invoice.
The business owner is provided with a bank trust account where the transactions takes place, so the debtor is unlikely to know who provides the funding – unlike factoring where the debtor deals directly with the finance company. There are no personal guarantees or debenture taken on the company assets. Charges are explicit; no contracts are required to be signed and cash is paid within 24 hours of the auction closing.
However, as there are no personal guarantees or debenture, there is more emphasis placed on the quality of the debtor. Market Invoice will want to see well established larger firms, government backed or councils to gain access for funds. It only allows B2B businesses, so sole traders are not accepted.
There is a charging scale based on the turnover of the company and the quality of the debtor, so the invoice trade is not an absolutely true market-driven interest rate. Plus, Market Invoice is only interested in 30-120 days, limiting the scope of invoices accepted.
Platform Black has filled this gap and is challenging Market Invoice with a similar service with some subtle differences. Platform Black assesses each case on its merits, creating scope for sole traders. So, if there is the need, the online broker will ask for a personal guarantee or debenture if you are agreeable to the terms. As Platform Black may have the security it needs unlike Market Invoice, there is no need for a charging scale to be added, so the trade is a true reflection of the market place and the investors trading belief.
However, like Market Invoice Platform Black prefers well established larger firms with good Experian ratings to minimise risks within the B2B sector. It is only interested in short term debt (30-90 days), which also limits the possible invoices applicable.
Alternative lenders (Crowd funding/Peer to peer lending)
There is confusion in the market around the difference between peer to peer and crowd funding, but in essence there is little or no difference. The names simply originate from two different directions: the crowd funding technique that has become popular among music fans; and raising cash from investors via the likes of Kickstarter (peer to peer). Peer to peer is the more commonly recognised term for raising capital.
This market has expanded rapidly, having grown from lending £492m in 2012 to £1.4bn in the last twelve months. This is on top of the government committing a further 3.4bn to alternative lenders in the next year.
Social media such as Facebook, Twitter, LinkedIn and YouTube are playing a part in the growth of this market. A recent study in Illinois found that there was a direct relationship between the use of social media and the success of peer to peer lending. However the free and easy growth of the sector has been tightened somewhat since FCA started to regulate the market and issued guidelines to peer to peer lenders in March 2014.
Zopa is the largest of the alternative platform lenders with lending of £520m, but this is not business specific. Funding Circle has government backing and has loaned over £268m to 28,750 UK businesses. Funding Tree may be more useful if your client is looking for start-up finance, which may not be Funding Circle’s core market.
In the majority of cases business owners benefit from lower rates due to the potential investors bidding on the loan required, so there are no middlemen charging admin fees. The loan is usually agreed much more quickly than a bank might, and less supporting information is normally required. Lenders will want to see at least two years accounts and will not want to see a poor credit rating, though will take each case on its merits.
There is an online application where the proposal will be assessed for risk and rated. The risk rating reflects the strength of the proposal according to the Funding Circle’s assessment, allowing investors to decide whether they want to accept the risk or not.
One downside is that the investors will decide whether they invest in your proposal and accept your terms, so your company’s risk assessment could be seen by competitors.
What about banks?
In five years’ time I believe the banks will change their approach radically to focus more on the B2C relationships and leave SME lending to the alternative sector. The banks will undoubtedly cherry pick and no doubt buy the larger alternative players, and perhaps even dabble themselves.
Banking started when local communities decided to get together to fund major projects. The alternative finance market has now taken control of that role. The sector will only continue to grow and the finance market will look very different than it does today; hopefully for the better.
Mike Smith is director of Jameson Smith & Co a business debt specialist. Mike provides business turnaround and insolvency advice and solutions to UK company directors and accountants.