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Computer Says No, But We Have Alternative Funding.

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Alternative funding organisations offer customers borrowing capabilities that traditional banks are unable or unwilling to support. Bank finance and alternative finance is currently run very separately, but with the threat of legislation upon banks, as suggested by the Basel Committee, which could force them to to give more information to customers about alternative lending options, there is now an opportunity to get ahead of the regulations and find a mutually beneficial way to work with alternative funding providers.

With a new approach to working together, banks and alternative funding providers could create comprehensive financial packages that promote entrepreneurial spirit and support SME growth, while being more transparent and making it easier for SMEs to understand their options and choose the best one for them.

The many guises of crowdfunding

The term “alternative funding”, sometimes referred to as “alternative finance”, covers a wide range of funding sources. Crowdfunding is the one that has hit the headlines and created mass awareness of these opportunities. Crowdfunding sites have given individuals a new route into the investment market, as well as giving community-based projects a way to channel their messages and gain donations.

The primary alternative funding models are summarised below:

o      Investment-based crowdfunding is where investors fund projects in return for a financial gain, either in terms of equity or interest payments.

o      Equity based crowdfunding is a lending model whereby a person or organisation can appeal to many investors to buy equity in their business in return for funding. Using online platforms, brands such as Indiegogo, GoFundMe and Crowdfunder connect would-be investors with new start-ups, brands, or causes that need a cash injection.

o      Peer to peer lending sites, such as Funding Circle, connect businesses with multiple small investors to acquire the funds they need. The business pays interest on the amount borrowed. In April, Funding Circle announced that it had completed $150m of fundraising, resulting in the business being valued at $1bn in under 5 years.

o      Donation-based crowdfunding is popular for charities, arts, and cause-related fundraising in situations where an investor is generally motivated by a social or moral cause to participate.

o      Reward or incentive based crowdfunding typically offers an escalating level of reward in return for increased investment. Rewards may include discounted products, VIP access to new products or events, or simply an email of thanks or a mention on social media. Kickstarter is a great example.

o      Online loan platforms enable users to set and control the amount of money they require, and select a suitable repayment term. Some of these platforms demand astronomical APRs, but they can feed a need for quick turnaround of cash provision which can be available within days or hours instead of weeks or months.

We’ve already said no

Many in the banking industry fear alternative funding providers, but I believe this fear is unfounded. Those who look for alternative funding typically do so only after approaching (and being turned down by) traditional banks. John Allan, the National Chairman for the Federation of Small Businesses, recently reported that 35 per cent of SMEs are still being refused loans by the big four banks. Faced with a closed door, these businesses are looking at alternative funding solutions for the means to make their ambitions a reality.

Another reason why SMEs are flocking to alternative funding providers is that they can move quickly; Ezbob claims to be able to approve loans of up to £120,000 online in just 30 minutes. By uploading business accounts, bank statements and other key financial data, the computer systems are able to calculate risk and determine an offer for the customer without the applicant leaving their desk. This may be more of a concern for the banks, who are often saddled with clunky legacy systems that do not enable them to move quite as fast this, but even if they could, the risks of lending in this way would currently be too great for the banks to take on.

Alternative funding providers can take the risks traditional banks do not allow, and offer customers increased flexibility in the face of rigidity. This model can work in harmony with the banks’ lower-risk policies without giving the banks anything to fear – after all, these are customers who they have already turned down.

The rise of alternative finance

Alternative funding is growing at an astonishing rate, almost doubling in value year on year for the last five years, to an estimated value of £1.74 billion in the UK alone in 2014. Total lending by the industry has now reached £3.15 billion. This growth is partly attributable to the financial crash, which saw traditional banks less able to take risks with business or personal loans. Along with social trends and technical advances which have seen an increase in online peer to peer collaboration and a decrease in the monopolies of traditional organisations, conditions have been perfect for the exponential growth of alternative funding.

Reining in the crowd 

In October 2013, the FCA announced plans to impose new rules on the crowdfunding market, afraid that naive investors could be lured into crowdfunding in search of healthy returns for their savings, with little awareness or consideration of the risks. The new rules came into place in April 2014, introducing criteria for investors’ eligibility to ensure they are aware up-front of the risks of their investments, and able to withstand any losses they may incur.

Investment-based crowdfunding platform providers are now only allowed to market crowdfunding opportunities to regular investors, or those that take regulated advice, or those who can confirm their investment does not exceed 10 per cent of their net assets.

And it is not only the regulator who is apprehensive about alternative funding practices. Research carried out by Nesta and the University of Cambridge (Understanding Alternative Finance: The UK Alternative Finance Industry Report 2014) found that would-be customers also have concerns about using the services. A lack of regulation sparks fears over safety and longevity, and a lack of understanding of alternative funding business models makes it uncomfortable to proceed. I would be remiss if I didn’t also confess to having concerns when reading about some of these practices during the research for this blog.

The vital role of traditional lenders

Removing some of this anxiety and concern for customers who are dealing with alternative funding is where banks could come into their own. As trusted experts in the lending markets, the banks could take up the role of offering help and advice to customers who have not met the criteria for traditional lending services, but need guidance in finding an appropriate alternative finance solution.

A long-term lending package, in consultation with a bank, could combine alternative finance solutions for a business while they are still considered high risk, with the conditional acceptance of a more traditional bank loan further down the line. This would set the business up for a financially healthy future, as long as they can get through the more risky early stages.

Being open to working with alternative funding providers could help banks to re-establish their reputations as enablers rather than obstructors. Embracing innovative and colloraborative alternative finance models would allow banks to access new markets and new technologies, while demonstrating that they are modern ‘full service’ customer-centric brands, focused on helping customers find the most appropriate solution at the time of need. Collaboration such as this would bring good old-fashioned banking principles to our digital age – and not a moment too soon.

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