How to invest in your business: Alternative finance
Even at the best of times, many small businesses worry about taking on debt, particularly when it means putting up the things they hold dearest as collateral, or sticking to a rigid monthly payment plan during unpredictable trading periods. That all-important APR can come back to haunt you if you haven’t taken full account of potential fluctuations over the repayment period. Late and early repayment fees only add to the pain. Before too long that short-term loan to invest in your business might actually be undermining your financial security and growth prospects.
My Way or the Highway
Then there’s the question of choice. Those that do take the plunge and seek out finance have found their options limited. You go to the bank, put your case forward, they make a decision on what you can afford to borrow, and provide the terms of repayment. It’s a process that has barely changed in the past millennium. There’s nothing fundamentally wrong with the system – but it doesn’t work for everyone.
Research shows that 50% of loan applications from first time SME borrowers are rejected, limiting ambitions they had to invest and grow their business.
So what’s to be done? Well until recently not very much. In recent years a wave of innovation in the financial services sector. With it came the promise of greater choice and flexibility for small businesses, not just in terms of whom they approach for funding, but how they structure repayments.
An alternative way
Alternative financing is the umbrella term for a new, technology-led approach to funding. It covers everything from peer-to-peer lending (lending money to individuals or businesses through online services that match lenders directly with borrowers) to equity crowd-funding (funding a project or venture by raising monetary contributions from a large number of people, often performed via internet-mediated registries). The UK has by far the largest online marketplace for funding, when compared with other European countries, valued at €2.4 billion in 2014.
Alternative lending for businesses may have only started in the UK a few years ago, slightly behind the US market, but it seems as though 2015 was the year that it rapidly caught up. And the sector grew by a reported 75% to £1.26 billion in 2015.
What’s driving this growth? In part, alternative finance provides a level of choice and flexibility that many small businesses find is better suited to their business needs than traditional lending.
One model proving popular is the business cash advance, which offers the business owner an unsecured “cash advance” based on their future credit and debit card sales. It’s the route we went down with the launch of Worldpay Business Finance last year in partnership with Liberis.
Payments are made on the basis of a pre-agreed percentage of the business’ card transactions, so business owners only pay when they are earning and don’t face the stress of having to meet a regular monthly payment if business is quiet.
This flexible model of finance includes no fixed term and unlike traditional “loans”, business owners will not face penalties for failing to make a payment. Furthermore, if the advance takes longer to pay off, the originally agreed payment costs remain the same.
This flexible approach to finance is particularly suited to businesses looking to invest over a relatively short period, either to make improvements, or to buy stock in advance of a busy trading period; a florist needing to get in a bumper order prior to Valentine’s Day, or a restaurant owner wanting to keep his customers happy during colder nights by investing in outdoor heaters. That extra cash injection can be the difference between success and failure.
Purdy’s of Brighton Jewellers is a great example of how this flexible approach to finance can be put to effective use. Owner Martin Purdy spotted an opportunity to sell pre-owned jewellery and found it became a major part of his business. But to take advantage of the increasing number of sellers coming in to the shop ad hoc to trade with him, he needed additional cash flow. The funding he received helped him differentiate locally and take his business to the next level.
Stories such as this are part of the reason alternative finance has gained traction so quickly. Despite the rapid growth of the industry however, awareness remains low. Just 9% of UK SMEs hade tried or used alternative financing as of 2015. There’s work to be done to ensure all small business owners are aware of the options available to them when looking for funding. But as we settle into 2016 and look back on the evolution that has occurred over the past year, it is fair to say we are already some way along the path to an amazing transformation in the alternative lending industry.