Alternative finance is a broad term intended to include almost any source of business funding other than the traditional bank loan or overdraft.

Within the category of alternative finance can be found:

Crowdfunding

Crowdfunding is a way of funding a project by raising money from a large number of people (a crowd) who each contribute a relatively small amount, usually via the internet. As the concept of crowdfunding has become more common, it has moved away from simply donations to individuals to fund a personal project or to a charity and is now used to fund business ventures without the need to involve banks.

There are four main types of crowdfunding:

  • donation
  • reward based (the money is linked to a reward from the project or cause)
  • investment – based (usually used by businesses, where the investor receives a stake (normally shares) in the business)
  • loan-based (see peer-to-peer lending below)

The business seeking to raise funds will put a pitch for their project on a crowdfunding website, including the amount it wishes to raise, what the funds are to be used for and what shares (if any) are being offered. As a business intending to use investment-based crowdfunding, you will need to review, and possibly alter, your share structure to enable shares to be issued to new investors, consider what rights such shareholder will have and how these will vary from the rights of founder shareholders.

As a potential investor, a person would also be interested in seeing how long the pitch has been open, how many other people have already invested and how much has been raised to date, which will all be indicators (but not a guarantee) of the project being fully funded.

If the target is not reached, then the project cannot go ahead, and new businesses using crowdfunding should be aware that investors have 14 days in which to change their mind and withdraw, which makes this a potentially unstable source of funds. The crowdfunding website collects the investor’s money, which should be placed in a separate account, until the target is reached and then the money is forwarded to the business.

Each crowdfunding website will have its own terms and conditions and may charge a fee for its use.

As either a funder or a business, it is important to note that only investment-based and loan-based crowdfunding is regulated by the Financial Conduct Authority. Check the crowdfunding platform you are intending to use is authorised – check the Financial Services Register.

Peer-to-peer lending

Peer-to-peer (P2P) or peer-to-business (P2B) lending (also called ‘social lending’) is loan-based crowd funding. The idea is to match up via an intermediaries operating an online ’platform’ people who want to borrow money with people who want to lend it. The lenders may be individuals or institutions. The lender provides a loan to the individual or business in return for a set interest rate.

  • like all business funding, the amount available to a business and the cost (rate of interest) will depend on the business’s credit rating
  • peer-to-peer lending may be particularly attractive to businesses with a strong credit rating or only seeking a small loan, as they may not be subject to a minimum loan amount (unlike some bank lending) and the interest rate can be lower than traditional bank loan rates
  • conversely, peer-to-peer lending may be a source of funding for a business that is not eligible for a bank loan, but for such businesses the interest rates can be extremely high

Unlike investment-based crowdfunding, a business seeking funding from peer-to-peer lending does not submit a pitch for its proposal to the crowdfunding website, but instead registers with a lending site to select the amount it wishes to borrow and for how long. The business will immediately receive a notification of whether it is eligible for a loan and the applicable interest rate or rates (where parts of the loan are available on different terms). The loan amount is made up of ‘parcels’ of loans from a number of lenders.

The terms of peer-to peer lending, and the way the loans are operated, will vary between different platforms, so it is important that any business using this type of funding properly understands the terms and costs (including arrangement fees and fees for using a platform) of any peer-to-peer loan they take out.

A failure to repay a peer-to-peer loan will meet the same consequences as any other form of borrowing, including debt recovery action, enforcement of any security or guarantee and an adverse entry on the credit report of the borrower and any security provider.

FWJ’s banking and finance team has extensive experience advising on the set up, operation, provision and collection of peer-to-peer lending platform facilities and can advise both borrowers and lenders on this type of business funding.

Micro loans

Microfinance is a type of direct lending offering financial services to low income individuals or groups of people who do not have access to other finance. This may take the form of a traditional term loan or a peer-to-peer loan (see above).

As with any other loan, micro loans can be used for business funding, for example as working capital for a small or start up business, buying inventory or general funding needs such as short term liquidity.

For a new start up or small business with no credit history or security to offer for the loan, the higher lending risk attached to micro loans is usually reflected in the interest rate charged.

Specifically for small businesses in the UK, the government offers a number of micro business loans for small business ventures.

Financial services lending

Financial services lending, or ‘marketplace lending’, refers to online platforms (‘Fintech’) that enable lenders to lend money to retail and commercial borrowers on secured and unsecured terms.

Whilst marketplace lending is an emerging trend in the banking and financial services sector that uses developing technology to enable these finance providers to offer their products and services on new platforms rather than via traditional bank branches or even via online banking, not all marketplace lenders are banks. Generally marketplace lenders do not take deposits or lend money themselves or carry risk but act as an intermediary to collect the principal and interest from the borrower and pay this (less their fees) to the lenders.

Marketplace lending can be used both for new loans and to refinance existing debt.

For potential borrowers, the benefit of the increased use of technology in financial services has led to lower borrowing costs and more creative lending solutions, such as peer-to-peer lending (see above) often on more responsible terms and at lower costs.

Equity finance

We would refer you to our detailed pages on Share sales.

Angel investments

An angel investor (sometimes called a private investor, seed investor or angel funder) is a high-net-worth individual who provides financial backing for small start-ups or entrepreneurs, usually in return for a share in the equity of the company. In this way, angel investments are similar to equity finance (see above), but usually provide a smaller amount of capital (albeit still substantial) and a minority interest.

Whilst an angel investor might be a family member or friend of the (lucky) entrepreneur, these individuals may be unconnected to the business but have spare cash and are looking for a higher rate of return than is available from traditional investments. Often these people are attracted to a start-up because the proposed business activity is in a sector important to them. Angels have become a vital source of funding for many start-ups. An angel investment might be a single sum or be on-going support.

As with all forms of alternative finance, the internet is the start-up’s friend and there are websites aimed at connecting UK entrepreneurs with angel investors – https://www.angelinvestmentnetwork.co.uk/ ]

The terms of an angel investment are driven by the angel: the business presents a pitch which, if successful, will be followed by a due diligence review into the business. If this is satisfactory, the angel will offer lending terms. A start-up business can expect active involvement in the business from the angel, which can be a valuable source of business expertise, not least because the angel will generally be looking for a high return on his investment and a rapid exit on a few years later.


FWJ’s experienced banking and finance team can provide expert advice and support to start-up businesses on the terms of loans and investments offered to them to meet their needs for business funding.

Key contacts

Kieran Cummins

Kieran Cummins

Solicitor

Sally Bradshaw

Sally Bradshaw

Senior Associate

Chris Willison

Chris Willison

Partner

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