Op-Ed: Is alternative finance a silver bullet for SMEs seeking funding?

Posted May 13, 2015 by Elizabeth Grey
Alternative finance is the small and medium-sized enterprises (SME) world’s latest buzz term, promising companies a flexible recourse from a financial landscape dominated for too long by the shrinking availability of bank loans.
UK based ARCOL Resistors  is the long established specialists in resistor technology.
UK based ARCOL Resistors, is the long established specialists in resistor technology.
Department for Business, Innovation & Skills
Demand for credit is outstripping supply for all British businesses and this gap is experienced most severely by small and medium-sized enterprises. Alternative finance, particularly in the form of peer-to-business lending and crowdfunding, is rapidly filling the gap. Between 2011 and 2013 alternative finance grew by 254%, going from a niche to mainstream.
New legislation will make it compulsory for banks to refer SMEs to alternative sources of finance if they are refused credit, potentially increasing these numbers even further.
Is alternative finance a silver bullet for SME funding woes? What could be preventing businesses accessing it?
How does the application process differ?
Applying for alternative finance can be a very different process to applying for a bank loan.
Crowdfunded proposals not only require the same business plans, financial calculations and projections that are needed for a bank loan or overdraft application, but also marketing savvy. The most successful business crowdfunding proposals often involve social media campaigns and video production; skills that not all SME owners or managers possess.
Potential applicants should be aware that accessing alternative finance brings with it an obligation to adhere to strict FCA guidelines, so in practice most companies use third-party platforms, who vet investors and ensure that their clients meet their legal obligations.
Is it always appropriate?
Businesses don’t just seek credit to fund expansion. SMEs often need a short-term injection of working capital to cover a shortfall caused by late invoices, an issue highlighted by Vince Cable when he was in office.
According to the Federation of Small Businesses (FSB) late payment of invoices is experienced by 73% of small companies. The cash flow problem this can cause can be enough to bring a company down, yet crowdfunding or peer-to-business lending may not be the most appropriate solution. This is due to length of time it can take to create a viable campaign or complete due diligence.
The British Business Bank reports that in this case bank overdrafts and loans are the most popular recourse among SMEs, being the first choice of 40% and 18% of businesses respectively.
Another factor businesses need to consider is that unlike the reward or donation-based crowdfunding, which is often used for charitable or creative projects, commercial offerings generally need to choose between providing bonds or equity in exchange for investment.
Bonds don’t dilute company ownership, but they may require companies to put up assets as security, which may be an issue for start-ups or businesses whose main resources are intangible.
Do SMEs know enough about it?
Britain is leading the world in alternative finance innovation, yet many SMEs seem unaware of how it works and how it can help them. 18% of business owners surveyed by The British Business Bank said that they would give up if rejected by their first choice of lender, while only 23% said they were aware of peer-to-peer lending, and just 12% were familiar with crowdfunding.
Worryingly, the percentage of those who said they would know who to approach about either method were even lower, at 11% and 5% respectively.
Medium-sized enterprises displayed consistently higher levels of awareness than sole traders, micro or small businesses. Job creation is one of the most significant economic benefits of SMEs and these businesses need capital to grow into medium-sized businesses, creating more jobs and boosting the economy.
Awareness is concentrated in certain business areas too. It’s much higher among those operating in communications, business services and technology compared to construction and services, suggesting that some sectors may be benefitting from alternative finance more than others.
How does the digital divide affect access?
SMEs are increasingly divided between those who embrace the rise of digital technologies and those who don’t. SMEs who consider themselves digitally mature tend to report above average business performance. However, the same study shows that 29% of SMEs don’t think having a digital presence is relevant to them and 1.6 million don’t have basic digital skills.
Peer-to-peer lending and crowdfunding is an internet phenomenon, and given the importance of social media awareness to many crowdfunding campaigns, this lack of digital know-how could be costing businesses the ability to raise funds using alternative finance.
Alternative finance offers SMEs unparalleled flexibility and opportunity to raise capital, but there’s still a healthy demand for bank overdrafts and loans, especially for short-term needs. This needs to be taken into considerations when looking at how to improve access to credit for SMEs.
In addition, to ensure that British businesses benefit the most from alternative finance, they need to be made aware of how these work and how to increase digital skills, with particular attention to sectors that may be being left behind.