Alternative Finance - Crowd Funding
Expectations are growing that alternative finance providers can step into the gap left by mainstream lenders when it comes to funding the UK’s smaller businesses.
Since the Breedon Taskforce identified a potential £59bn funding gap for SMEs up until 2016, alternative providers have built up considerable momentum. The market need is clear, the technology solutions are readily to hand and the regulatory path to setting up an alternative funding provider is, for now, a navigable one.
Alternative finance might be in its infancy, but it doesn’t entirely lack a track record. As Helen Brand, ACCA chief executive, pointed out as she introduced ACCA’s first Alternative Finance Conference last month, while the US has arguably led the way in developing a viable alternative finance provider market, alternative finance has also come a long way in the UK in a short time, and increased competition is likely as more new players come on stream.
‘2013 can and should be the year that crowdfunding and peer-to-peer finance come of age, as properly regulated services serving mainstream business,’ said Brand. ‘Despite the sluggish recovery, alternative providers are still benefiting from a benign climate: widespread mistrust of the banks and the financial system, rockbottom interest rates, substantial interest from venture capitalists and now government support too. It cannot always be this way and the incumbents know this.’
The key speaker at the event was Jo Swinson MP, minister for employment relations and consumer affairs in the Department for Business, Innovation and Skills. She said the government is keen to act as a catalyst, encourage innovation among alternative finance providers, while also ensuring protection for the public. ‘The Financial Conduct Authority welcomes changes that mean members of the public can become lenders as well as borrowers. There is huge potential here, but regulation is not the only key to growth. It will also be down to whether the lenders build a service that is valued by investors and businesses.’
Indeed, the government has moved to support these new channels for small business finance. It has put £100m towards alternative business finance providers via the Business Finance Partnership scheme, including £30m to online peer-to-peer lending platforms. In the latest round of this funding, invoice finance platform, Market Invoice, received £5m to be deployed towards meeting working capital needs in the SME sector.
So what does the provider market look like and how has it developed in the UK? Andy Davis, former FT journalist and author of Seeds of Change: Emerging Sources of Non-Bank Funding for Britain’s SMEs (Centre for the Study of Financial Innovation, 2012), said at the event that the conditions that enabled alternative finance to develop are clear.
The UK was ready for take-off in terms of its adoption of alternative funding, he said. ‘The UK is unusually advanced in its take-up of comparison websites, insurance sites and so on. These sites make rapid decisions, and the style and tone of content on the websites indicate a more approachable breed of organisation.’
The key advantage for businesses is that it enables them to diversify financing risk. In the autumn of 2008, owner-managers discovered the risks inherent in single bank relationships, Davis argued. Other advantages include speedy decisions in days not months, much greater flexibility around terms, a relationship that doesn’t lock the borrower in; guarantees that are less onerous; and competitive rates available to armchair lenders. ‘It democratises funding for small businesses,’ said Davis.
Simon Deane-Johns, solicitor at Keystone Law and formerly general counsel and company secretary at peer-to-peer finance marketplace Zopa, pointed out that alternative finance is not really driven by the recession. Zopa was established in 2005 during a credit boom, when spreads between savings and loans were very narrow. What Zopa and players that have launched since are responding to, he said, is a way of operating that reflects consumers’ growing interest in dealing with fellow consumers and businesses directly, rather than institutions or faceless corporations.
A key feature of that is a minimum of intervention by the platform itself. The platform directly connects the investor or the lender to the borrower or entrepreneur. That platform manages the funds flow that results from those direct transactions. The investor pays into a segregated account and the operator allocates those funds to the borrowers and any subsequent repayment.
On the downside for the overall development of this sector, said Deane-Johns, there may be a greater investor risk, which will vary according to the type of instrument, ranging from loans to debt investments to equity in startups. So there’s a contradiction emerging. Providers need an environment in which they can thrive and innovate, but this widening pool of investors and lenders needs protection.
This is not an issue that the providers can dodge. ‘It is incredibly important they build a solid reputation because of the visibility in the social media of both the industry and individual deals and transactions,’ said Deane-
Johns. Secure, reliable IT will play a role in that, as will vigilant customer services. ‘Platforms are very keen to understand any customer problems day to day, typically using Twitter to flag confidential matters, but taking those offline to address concerns.’
There is additionally a risk of regulatory creep. When it comes to setting up, there can be confusion over what is lawful as well as is what is overlap between UK law and EU directives. What’s more, even slight changes to the way in which providers operate can have disproportionately large outcomes.
So what is the role for accountants? The Breedon Report advocated support for the provision of more diversified forms of debt finance, but noted the lack of independent advice around or government support for alternative finance providers. In fact, professional accountants are ideally placed to provide independent advice on this market. The introduction of the Business Financial Advice Scheme, a kitemarked organisation encompassing ACCA, the Institute of Chartered Accountants in England and Wales, and the Institute of Chartered Accountants in Scotland-accredited practices, provides access to firms that are primed to include advice on non-bank sources of business finance. ‘Business needs the right mix of finance going forward,’ said Glenn Collins, head of technical advisory at ACCA.
Swinson urged accountants to ensure their clients are aware of the possibilities that alternative providers bring: ‘Raising finance is always challenging. The events of 2008 made it even more acute. But it is critical to our economy that SMEs have access to funding and that must include alternative forms.’
The regulatory issues will have to be resolved but, in the meantime, crowd due diligence is already emerging on these platforms, with participants asking questions of both borrowers and sponsors. There are, said Davis, quite serious interrogations going on.
It seems possible that the democratising effect of these platforms may lead to a new class of mass angel investors with diversified portfolios made up of quite small stakes – 20 times £5,000 perhaps. And with major sites growing at upwards of 100% per year, it’s not skygazing to suggest that this might be a £1bn industry within five years, he said.
Louise Beaumont, chief sales and marketing officer at Platform Black, doesn’t see any halt on growth ahead. ‘With Basle III regulations demanding even higher levels of capital retention, the potential for alternative funding to grow is huge. Terms available from mainstream sources are hugely disincentivising. Business people are still seeing overdrafts withdrawn and reduced. SMEs have been sitting on their hands to a degree, but we need to get the message out there that they have options. Alternative finance is small now, but we are growing at a time when lending to SMEs is going backwards.’
Greater involvement from a new breed of armchair investors or lenders would boost the growth of crowdfunding and peer-to-peer lending. And the government could assist that trend while at the same time addressing a systemic issue within the UK’s financial system. An estimated £400bn is currently held in individual savings accounts, half of which is in cash deposits earning largely risible rates of interest. If the Treasury responded to calls to expand the range of assets that can be held within the ISA wrapper, it would enable savers to diversify and get a better overall return. SMEs, via alternative finance providers, could be the beneficiaries. And a key logjam within the UK financial system might be removed.
As Simon Deane-Johns says in his blog, the Fine Print: ‘There is a dawning recognition that it’s up to entrepreneurs and private investors to connect the dots between the low returns on savings and the fact that SMEs face a funding gap of £26bn to £52bn over the next five years.’
Liz Loxton, Journalist
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