Alternative Finance

Business finance can be challenging for UK small to medium-sized enterprises (SMEs), particularly when traditional high street banks and lenders impose strict underwriting criteria. These conventional approaches often favour businesses with extensive trading histories, robust financial statements, and flawless credit scores, leaving many innovative startups and established SMEs with less-than-perfect credit or unique operating models feeling overlooked. This is where alternative business finance steps in, offering a diverse landscape of funding solutions designed to be more flexible and accessible.

Understanding the Landscape of Alternative Finance

Alternative finance refers to funding sources outside the traditional banking system. These lenders often use different assessment methods, focusing on a business’s overall health, cash flow, and future potential rather than putting a lot of reliance on historical performance and credit scores. This broader perspective means that businesses previously turned down by mainstream lenders may find a suitable financial partner. The alternative lending market in the UK has grown significantly, indicating its role in supporting SME growth and addressing funding gaps.

Key Types of Alternative Finance for SMEs

The alternative finance sector offers a variety of products, each suited to different business needs and circumstances.

Flexible Lending Options

These are some of the products that offer a more adaptable approach to traditional loans.

• Merchant Cash Advance: This is a popular option for businesses that process volumes of debit and credit card payments. Instead of a fixed loan, the lender provides a lump sum, and repayments are taken as a small, agreed-upon percentage of future card sales. This means repayments naturally align with your business’s cash flow and  you pay back more when sales are high and less when they are slow. It’s often available even for businesses with an imperfect credit history, as lenders focus on recent card transactions.
• Unsecured Business Loans (from alternative lenders): While traditional banks may require collateral for loans from businesses in like for like circumstances, many alternative lenders offer unsecured loans without the need to pledge assets. They assess eligibility using a wider range of data, including real-time business performance and open banking data, allowing for quicker decisions and more flexible terms than traditional bank offerings.
• Short-Term Business Loans: Designed to address immediate cash flow needs or seize quick opportunities, these loans typically have shorter repayment periods than traditional bank loans. Alternative lenders are often known for their rapid application and approval processes, with funds sometimes available within days, but keep your eye on the costs.

Asset-Based Solutions

These options leverage a business’s assets to secure funding.

• Invoice Finance (Factoring and Discounting): If your business issues invoices to customers who pay on credit, invoice finance can unlock that cash. You sell your outstanding invoices to a finance provider who advances a percentage of their value upfront. Once your customer pays the invoice, you receive the remaining balance, minus the provider’s fees. This is a solution for managing cash flow, especially for businesses with long payment terms.
• Asset Finance (Hire Purchase and Leasing): This allows businesses to acquire essential equipment, machinery, or vehicles without a large upfront capital outlay. With hire purchase, you pay instalments and eventually own the asset. With leasing, you effectively rent the asset for a period, which can be useful for equipment that depreciates quickly or needs frequent upgrades. This type of finance is secured against the asset itself, making it potentially more accessible. It’s often easier to obtain as the asset acts as security.

Equity and Community-Based Funding

• Crowdfunding: This involves raising small amounts of money from a large number of individuals, often through online platforms. It can be equity-based (investors receive shares in your company), debt-based (investors lend you money to be repaid with interest), or reward-based (investors receive a product or service). It’s a way to gain funding and also test market interest in your product or service.
• Peer-to-Peer (P2P) Lending: P2P platforms connect businesses directly with individual or institutional investors who are willing to lend money. This bypasses traditional banks, potentially offering more competitive rates and flexible terms. The specifics vary by platform, but the general idea is for borrowers to gain quick access to funds while investors earn interest.
• Community Development Finance Institutions (CDFIs): These are non-profit social lenders that specifically aim to support businesses and social enterprises that struggle to access mainstream finance. CDFIs often provide finance to underserved groups, including those with less conventional business models or in areas of higher deprivation. They can also offer additional support and mentoring.

How Alternative Lenders Assess Businesses

Unlike high street banks that often rely on rigid scoring models, alternative lenders adopt a more holistic and flexible approach. They typically consider:

• Cash Flow: A strong emphasis is placed on the business’s ability to generate consistent cash flow, indicating its capacity to repay the loan.
• Operational History: While some alternative lenders support startups, some look for a trading history, even if short.
• Future Projections: Lenders may assess your business plan and future financial forecasts to understand growth potential.
• Open Banking Data: Many alternative lenders leverage Open Banking technology to gain real-time insights into a business’s financial health directly from their bank accounts, speeding up the decision-making process.
• Sector-Specific Knowledge: Some alternative lenders specialise in particular industries, allowing them to better understand the unique risks and opportunities of those sectors.

Alternative Finance for Larger Businesses

While primarily serving SMEs, alternative finance concepts also extend to larger businesses. For example, private credit funds are a significant part of the alternative finance landscape for larger corporations, providing customised debt solutions that might not be available from traditional banks. Similarly, larger companies may use sophisticated invoice finance or asset finance structures to optimise their working capital. The general principle remains the same: offering flexibility and tailored solutions where mainstream finance might be too rigid or slow.

Key Advantages for SMEs

• Increased Accessibility: A primary benefit is access to funding for businesses that don’t fit traditional lending criteria, including those with less-than-perfect credit scores or limited trading history.
• Faster Decisions and Funding: Alternative lenders often use streamlined online application processes and advanced technology to provide quick decisions, sometimes within hours and disburse funds rapidly.
• Flexible Terms: Many alternative finance products offer repayment terms that can be tailored to a business’s cash flow cycles, which is especially helpful for seasonal or project-based businesses.
• Focus on Business Potential: Rather than just past performance, alternative lenders are often more willing to assess a business’s current performance and future growth prospects.

Important Considerations

While beneficial, SMEs should be aware of certain aspects:

• Cost: Due to the increased risk taken by alternative lenders, interest rates or fees can sometimes be higher compared to traditional bank loans for businesses with excellent credit. However, the cost often reflects the flexibility, risk taken by the lender and speed of access.
• Regulation: Whilst many business lenders might be regulated, a good proportion of lending products for businesses are not regulated. The alternative finance sector is similar and so it’s essential to choose reputable lenders who are transparent about their terms and fees.
• Understanding the Product: With a wide array of options, it’s essential for businesses to thoroughly understand the terms, fees, and repayment structure of any alternative finance product before committing.

The rise of alternative business finance has created a more inclusive and dynamic lending environment in the UK, empowering SMEs to secure the capital they need to grow and innovate even when traditional routes are out of reach.