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Alternative finance: the funding options for small business

19 Dec 2019

Many businesses are started with the founder’s own money. But to achieve scale will often require additional funding. 

A key legacy of the 2008 financial crisis was that conventional sources of finance – bank loans – became even harder to obtain. Yet a diverse range of funding options has emerged to fill the gap, and these have been embraced by business, government and regulators.

The current alternative finance environment

The financial crisis of 2008 left many banks wary of lending to high-risk SMEs and start-ups for a low return. The intervening years have seen an increase in both the number of alternative finance providers and the amount of investment made available to British small businesses.

According to NESTA, the UK alternative finance sector was worth £3.2bn in 2015, with over a million people lending, investing, or donating using alternative finance platforms. Peer2Peer Finance News reports that peer to peer lending in 2016 had reached £2.9bn to mid-December.

2014 was a significant year – The UK Government completed the launch of The British Business Bank.  2014 also saw the Financial Conduct Authority extend its supervision to crowdfunding and peer to peer lending.

IoD members and alternative funding

The IoD’s policy statements and interventions on the subject of access to finance recognise two issues, amongst others:

Access to seed capital – Starting a business with financial support from family or friends presupposes that there is sufficient capital within the family to be risked on a business venture. The UK would gain more entrepreneurs and start-up businesses if access to seed capital was more structured.

Access to funding for scaling up – Turning a small start-up into a mid-size company generating wealth and employment usually requires a significant capital injection. The OECD reports that only 3 per cent of UK start-ups manage to scale-up to 10 per cent annualised growth in turnover and/or employees.

Research conducted amongst the IoD membership indicates –

  • Between 2011-2014, 55% of IoD members did not apply for a bank loan. IoD members who did apply for a bank loan faced a rejection rate of 29%
  • At the start of 2016, 75% of IoD members cited retained earnings as an important source of investment. 35% of IoD members described bank loans as important.

The research above would suggest that IoD members make enthusiastic use of alternative finance. But this is not case –

  • A survey of IoD members indicates that only 7 per cent regard non-bank finance sources as an important source of capital.
  • Even fewer IoD members (2% of survey sample) regard equity crowdfunding or reward-based crowdfunding as an important option.

However, when asked to assess the importance of alternative finance up to 2026, IoD members predicted large gains in both the relevance and utilisation of peer to peer lending, equity crowdfunding and private equity/venture capital. Younger entrepreneurs appear to be more ready to engage with alternative finance platforms.

Accessing alternative finance – Do your groundwork

Any business looking to borrow from alternative finance sources must appreciate the basic difference between debt and equity finance. A peer to peer loan (debt finance) binds the borrower to repay the loan amount and the agreed rate of interest. The borrower retains full ownership of their company. The equity model which predominates in crowdfunding and business angel investing means that a share of your business goes to the investor. Your new stakeholders may be source of support and guidance, or may dilute your control.

Visiting a few P2P or crowdfunding websites would suggest that the process of borrowing is easy. But, just as if presenting to your bank, you must be able to demonstrate reliable accounts and a solid grasp of cash flow. Where business angels are concerned, expect to have your accounts and forecasts closely examined by people who may have completed the business journey you have undertaken. Always remember, they want you to succeed!

Types of alternative finance

NB: The companies mentioned in this section are offered as examples of their kind. There are other companies active in each sector. The IoD does not recommended specific alternative finance companies.

The British Business Bank

The British Business Bank does not lend directly to small businesses. Instead it invests in several alternative finance platforms, and works to improve the function of capital markets in the SME/Start-up space. The bank’s website is a very useful source of information on how and where to access both conventional and alternative finance.

Peer To Peer Lending

Essentially peer to peer lending (P2P) enables people who have money to put it to work for competitive returns through lending to other individuals or businesses online. P2P activity in the UK is concentrated in a handful of online marketplaces which are members of the P2P Finance Association. The P2PFA members active in lending the small businesses are:

Funding Circle – The UK’s largest alternative loan marketplace, providing finance to businesses which have traded for at least two years.

MarketInvoice – Businesses can raise up to £1mn by selling outstanding invoices.

RateSetter – Business and personal loans, with the unique feature that interest rates are set by the lender and the borrower.

ThinCats – Secured business loans only, with borrowers introduced by a network of expert sponsors.

Zopa – Europe’s first and largest P2P platform providing personal loans.


In crowdfunding, a company or individual borrows a sum of money to which a large number of investors or donors have contributed.

There are three types of crowdfunding:

  • Reward – The investor or donor receives a non-monetary reward or incentive. A popular choice for raising funds for creative projects. Donors are mentioned in the credits of the independent film they supported, or receive a copy of the music album they helped finance, etc. Donation- and reward-based crowdfunding are not regulated by the Financial Conduct Authority.
  • Debt – A loan to receive a monetary return.
  • Equity – The lenders receive equity in the business which is raising funds.

Crowdfunding has gained in sophistication, with at least one UK site now issuing bonds. Amongst the best know platforms are:

CrowdCube – A specialist in funding for start-ups in return for equity

Kickstarter– Best known for high-profile reward-based funding in the creative industries

Seedrs – Equity investments in new businesses

SeedUps– Equity investments in technology start-ups

Crowdfunding has gained representation through the UK Crowdfunding Association (See the UKCFA website for a membership list)

Business Angels

Traditionally an experienced individual providing finance and guidance to new ventures, business angels in the UK now offer investment and expertise through the UK Business Angels Association website.

Whilst business angels are usually involved in start-ups, deals involving companies which are larger and already established can attract the attention of venture capitalists and private equity. Venture capitalists look for a high return from companies well positioned to succeed. Private Equity also seeks a high return and will often make interventions and improvements to a business in which it invests.

HMRC encourages equity finance in growth companies through the following  tax relief schemes:

Asset-based finance

A February 2017 report by Close Brothers showed that the majority of SMEs are unaware that they can borrow against their assets. Asset-based finance decisions are typically made on the quality of a company’s outstanding invoices, much like a one-off factoring deal. Asset-based finance sidesteps the credit history and worthiness issues which govern bank lending decisions.

Trade finance

According to Trade Finance Global, "Trade or export finance concerns domestic and international trade transactions – when a buyer purchases goods or services from a seller, the financial activities involved come under the umbrella term ‘trade finance’. Useful information is included in their SME finance guide.

Further information

IoD members can book a free appointment with our finance advisor to discuss options for raising finance:

Directors’ Advice: click to find out more

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