Alternative finance is an umbrella term that refers to a new financing mechanism that has emerged outside of the traditional financial system and helps connect fundraisers directly with funders often via online platforms or websites.
Alternative finance differs to traditional banking or capital market finance through technology enabled ‘disintermediation’, which means utilizing third party capital by connecting fundraisers directly with funders, in turn, reducing transactional costs and improving market efficiency.
An alternative finance provider is typically a business which administers non-bank funding to small and medium-sized businesses through loans, finance, or the purchase of equity. Most of the funding is generated through investments, loans, and donations, but the demand for this sector is based on mutual benefit.
Investors have more investment choices, enabling them to donate towards a cause or generate income based on their risk appetite (any investment promising a reward, investment, or return may come with risk). Borrowers benefit from finance that is easy to apply for and quick to obtain.
Products in Alternative Finance
Alternative finance includes several types of products. The distinctions between these products are
important as they differ immensely in the types of people and organisations that use them, why they use them and the nature, form and amount of financial transactions that take place. Examples of alternative financing activities through ‘online marketplaces’ are reward-based crowdfunding, equity crowdfunding, revenue-based financing, online lenders, peer-to-peer consumer and business lending, and invoice trading third party payment platforms.
Peer-to-peer (P2P) lending, also known as crowdlending, is similar to bank loans in that borrowers receive funds and are required to make regular monthly repayments with interest. The key difference in P2P is that funds are raised through a crowd of investors rather than a bank.
In some scenarios, loans may be put on a platform’s online auction for investors to bid on, making the interest rate payable dependent on the investor bidding process. In other cases, investors may be given a fixed-rate loan or a packaged product allowing them to invest in multiple loans through one investment. Once the auction is complete, borrowers are given the opportunity to accept or decline the loan terms.
Small business loans
Alternative finance also focuses on providing small business loans assisting young businesses who want low interest rates and flexibility in repayments.
Another common alternative finance product is asset finance. This is well-suited to large investments that are not immediately affordable to a business but represent a solid investment in its future. The finance terms are calculated on the value of the desired asset and the duration of repayment, making this solution suitable for businesses who want to split the cost of an asset into a more manageable repayment plan.
Capital is raised against invoices currently awaiting payment meaning receivables or cashflow and, by extension, business growth can be maintained in a fast-paced trading environment. This is generally suitable for businesses looking to free up internal capacity from chasing invoices, as lenders can take over this responsibility. This is usually for businesses with commercial invoices rather than public ones