Is alternative finance an equal contender to banks?

Alternative finance is claiming an ever-increasing share of the growth finance market. But is it a real contender, or just plan B for SMEs?

 Is alternative finance an equal contender to banks?

Since 2011, government and industry bodies have responded to growing market demand for non-traditional sources of finance to keep pace with developments in the business landscape. The UK has since successfully developed an alternative finance ecosystem geared towards innovation, competition, and growth.

Five years on, the alternative finance sector facilitated £3.2 billion in investments, loans and donations, a staggering 84 per cent increase from 2015 figures. The unprecedented scale and pace of the sector’s growth suggests that the best is yet to come for businesses looking for growth finance, and investors looking for opportunities.

Challenging traditional finance

Banks no longer hold a monopoly on finance, with new products such as crowdfunding and tax-efficient investment schemes allowing businesses to access vital growth capital without the added burden of time-consuming regulatory red tape. For Britain’s thriving community of scaling SMEs and start-ups, alternative finance is claiming an ever-increasing share of the growth finance market. The fluidity and speed offered has been vital in supporting Britain’s bustling community of businesses, ranging from early-growth start-ups to more established SMEs.

With the level of business awareness towards alternative finance rising through government and industry programmes, debt and equity crowdfunding platforms will continue to claim a growing share of the scale-up economy. The market has grown from £1.7 billion of loans, investments and donations in 2014 to £3.2 billion last year.

According to innovation charity Nesta, debt crowdfunding could be worth more than £12 billion in less than ten years, assuming that demand for investors and innovative start-ups continue to grow.

FCA concerns

Peer-to-peer (P2P) operators like Funding Options and Funding Circle, cut out banks by matching borrowers and lenders, while investment-based platforms like Crowdcube and Syndicate Room facilitate the buying and selling of company shares and bonds to investors interested in backing those products and services.  

The Financial Conduct Authority (FCA), however, recently raised concerns over both of these products in the market, considering the sector’s lightning fast growth. According to the FCA, investors may not clearly understand the risks and returns of crowdfunding due to misleading marketing material, and potential conflicts of interest. In April 2014, the FCA took over regulation of crowdfunding, but in reviewing the rules in July, the body believes P2P lenders too need to be reined in.

FCA chief executive, Andrew Bailey believes that the nature and role of these lenders has changed so drastically by introducing provision funds and attracting institutional investors. They function more like banks and asset managers now, except without the regulatory boundaries of those industries.

The regulator has proposed greater levels of disclosure by all crowdfunders and stricter rules on wind-down plans for peer-to-peer lenders.

Transparency will boost the industry and spike investor interest

According to Crowdcube co-founder Luke Lang, the industry needs a common set of rules and principles to measure the performance of the businesses on their platforms. “As the crowdfunding industry matures, we need a unified approach to reporting on the performance of crowdfunded businesses,” he explains. “Increased transparency of the due diligence process and ongoing performance of investments is critical for our maturing industry and investor confidence.”

Sacha Bright CEO of Businessagent.com, an independent regulated equity and debt crowdfunding aggregator, hopes that the result of the FCA’s consultation in 2017 will be a clear framework regarding the information that investors and companies need to make informed decisions.

“Transparency drives up industry standards and we would hope that this consultation is embraced by providers who we know are working hard to grow an industry that seeks to offer a second port of call for those looking for investment and funding to the mainstream banks,” she says.

But is there more to worry about?

“Traditional investors have had a tough year: interest rates hit record lows, inflation rates are set to increase and the economy is suffering from Brexit uncertainty. These events alongside low returns are encouraging investors to consider alternative investment options,” explains Lex Deak, CEO of alternative investments marketplace, OFF3R and founder of private investment firm, QVentures.

An independent index released by OFF3R, a marketplace for alternative investments, analysed major equity crowdfunding platforms including Seedrs, Crowdcube, Syndicate Room, Angels Den, Envestors and The House Crowd, alongside P2P lending platforms such as Zopa, Landbay, RateSetter, ArchOver, Marketinvoice, Lending Works, Funding Circle and Thin Cats.

Based on this research, Deak believes both crowdfunding and P2P lending can only benefit from greater regulation. “As the market matures, investors would like to see larger businesses turning to the crowd which may put pressure on the current £4 million limit. At the same time, we should see more standardisation in the way in which account and finance information is presented. This will make it easier for investors to be able to compare opportunities.”

The OFF3R index revealed that equity crowdfunding raised a combined total of £216.25 million and P2P facilitated a combined lending of £2.6 billion.

“P2P continues to be popular with investors, the market increased amounts lent during the post-Brexit period, with September being the strongest performing month on record with £234 million being lent. The Government has bought into its potential and the market is increasingly robust,” he says.

Measuring longevity

According to AltFi Data’s analysis of the businesses that raised finance using equity crowdfunding, by the end of calendar H1 2015, the sector saw 955 equity crowdfunding rounds by 751 companies. If the benchmark for success is delivering a return to investors via an exit, raising further capital (non equity) at a higher valuation, and showing no signs of distress, then the proportion of companies that are successes by that definition are yet to stand the test of time.

Companies that raised finance through equity crowdfunding in 2012 have fared exceptionally well, with 88 per cent of them hitting these metrics of success. Only 24 per cent of crowdfunded companies from 2011 made the cut, however. The report explains that the sample sizes in 2011 and 2012 are too small to be representative, and equally, not enough time has passed for either the 2015, or H1 2016 sample to have deviated significantly from plan, making it hard to discern too much from existing data.

The report also claims an average industry rate of return for investors of 8.55 per cent. When taking into account the tax reliefs that are available for crowdfunding investors, this figure jumps up to 19.14 per cent, suggesting that equity crowdfunding investments may have the potential to outperform the market.

Four in ten SMEs still prefer high street banks

As the lending market continues to diversify and grow, many businesses are still unaware that alternative forms of finance are available, compared to the high street banks. According to the Close Brothers Business Barometer, a quarterly survey of over 900 SME owners, mainstream banks are the first port of call for close to four in ten when looking for additional funding.

“While high street banks are still understandably a popular choice for many, there has been a strong rise in the role of alternative finance,” says Neil Davies, CEO, Close Brothers Asset Finance.

The view of three in four SMEs in the UK is that funding is no cheaper today than it was five years ago, notwithstanding interest rates dropping from an already low 0.5 per cent in 2011 to its current base rate of 0.25 per cent.

This is not a surprising result for Davies, who notes that access to finance continues to improve. “83 per cent of respondents to the business barometer (found) it was ‘as easy’ or ‘easier’ to access finance compared to five years ago,” he explains.

“Taking asset finance as an example, the latest figures released by the Finance & Leasing Association (FLA) show that asset finance for new businesses grew for the sixth consecutive year, with FLA members providing a record £30 billion of finance to the business sector and public services.”

While this represents almost a third of UK investment in machinery, equipment and purchased software last year, more may need to be done to reach SMEs.

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Weekly industry news roundup – March 6, 2017 - Bondora Blog

[…] Growth Business took a look at how marketplace lending is upending the old fashioned process of working through a bank for loan approval. “Crowdfunding could be worth more than £12 billion in less than ten years, assuming that demand for investors and innovative start-ups continue to grow,” remarked the author. Moreover, the author posits that increased transparency will boost investor’s commitment to the technology. […]