Alternative finance is often equated with peer-to-peer lending and other types of crowdfunding but there is more to it than that, according to Bryan Zhang, a director of Judge Business School’s Cambridge Centre for Alternative Finance. “It is any form of financial channels and instruments that have emerged outside the traditional financial system,” he said. This does include crowdfunding in all its forms (see last week’s article) but it also covers alternative currencies, such as Bitcoin; online currency exchange platforms; pension-led business funding; online invoice trading; and mini-bonds. Each of the last three can be used for business funding, either to improve cash flow or to access capital for growth.
“Invoice trading and pension-led funding are much less well-known in comparison to peer-to-peer lending,” said Zhang. “These are not more complex or more risky, they are just newer, and there is a smaller market than for other types of alternative finance.”
Invoice trading is the best known of these newer tools, probably because banks have offered a similar service for quite some time, said Zhang. The idea is that SMEs sell their unpaid invoices to investors at a discount, meaning that they get their money much faster than waiting for their clients to pay up, improving the business’s cash flow and reducing the amount of time that they need to spend chasing late payers. It is an approach that can prove particularly useful for consultancies and other businesses that sell services rather than products because it is not a loan, and therefore does not require the business to put up stock or property as collateral.
“Quite a few (start-ups) use invoice trading because the banks do not get their business model,” said Zhang. “Often these are from the knowledge economy – consultancies, say – and do not fit the standard borrowing profile. So sometimes banks do not get it but platforms like Market Invoice are fintech companies, and they get it. They know how to evaluate the risk because they have a better understanding of the business model.”
Online invoice trading platforms also offer a service that is cheaper and significantly more flexible than that offered by banks, he added. “If you go to a bank that offers invoice factoring it could take days, weeks or even months (to get your money) but online it would be minutes, or maybe hours.” It also gives the SME more control, as online platforms let sellers decide which invoices they want to offer up; banks, on the other hand, usually want all or nothing.
Pension-led funding, meanwhile, allows the owners or directors of an SME to tap into a pension fund – often one accrued while working in a more traditional corporate job before turning entrepreneur – through a SIPP to invest their money into their own business, said Zhang. “It’s liberating their pension pot to use for working capital or expansion capital.” It is not risk-free; it is also bound by the strict regulations that already govern pensions, he added.
One alternative finance growth area where regulation is still on the vague side is mini-bonds – ones issued directly by small companies. “Usually bonds are very much a corporate thing with some sort of rating behind them as a lending instrument offered to the public,” said Norbert Morawetz, a lecturer in entrepreneurship at Henley Business School. “With mini-bonds, companies offer structured loans (directly) to the public. In other words they are disintermediating.”
For investors and SMEs alike it is a market that “requires a bit more savvy” but gives the borrower more flexibility that is possible using a peer-lending platform. “With bonds (the borrower) has more control and can set their own rate and offer longer-term premiums than a platform would. And typically with bonds you can also trade them and sell them on, although I have not seen that yet. That (would) create a different alternative finance market to trade these bonds on,” he added.
Morawetz is curious to see whether such a secondary market will emerge – and indeed to find out which directions fintechs will take alternative finance next. “If you look at alternative finance now, it has replicated and innovated on what traditional banking used to do,” he said. “They have made it more efficient in some ways, for instance with the use of algorithms and big data. Beyond that it will be interesting to see what the new innovations will be. In some ways the big opportunities, the easy targets, have been addressed.”