The alternative finance industry is quickly becoming of vast importance in the business funding landscape and within the UK economy. The global economic crisis alongside a rise in technological innovation has improved the financial assistance available to SME’s amongst others. There are a variety of alternative finance models which have emerged and are continuing to develop.
There are several types of alternative finance available. This article will focus on Crowdfunding. Crowdfunding can take several different forms but usually fits within the following four categories:
- Donation based (small donations to meet a larger funding aim with no financial or material return in exchange);
- Reward based (donations towards a project with the expectation of non-financial tangible reward or product);
- Loan based (also known as peer to peer lending – debt based transaction between individuals and existing businesses with many individual lenders contributing to one loan); or
- Investment based (equity raised by offering investors an opportunity to subscribe for their shares or quasi-equity securities).
Although alternative finance is becoming hugely important within our economical arena it is still relatively innovative within the market with only 58% of people who are aware of the different funding options available and only 14% of those actually having used some sort of alternative finance platform, and when those figures are compared to SME’s awareness and use the figures are even lower, being 44% and 9% respectively.
The mis-selling of financial products has been a colossal concern for Britain’s consumers but also for the product providers over the recent years. The FCA has issued in excess of £300 million in fines for mis-selling activity since April 2013.
The FCA has recently indicated it was concerned as to how some crowdfunding websites did not publish information on risk and they were perhaps too optimistic and made clear its intention to support the growth of the alternative finance and crowdfunding sector whist recognising the risks involved in the early stages. Those risks include the following:
- Insolvency – Debt or equity securities through crowdfunding platforms are not usually listed. This increases the risk that an investor may be unable to realise their investment. Conversely, if the borrower did become insolvent, there are a number of issues which may arise for the borrower. The director of the insolvent company could be personally liable for the business debt if they agreed a personal guarantee with the alternative lender.
- Capital Risk – Equity investors will take the risk that any initial investment could be more than what is ultimately returned to them or the investment could be lost in its entirety. Many of the companies using crowdfunding platforms are in very early stages and risk is therefore increased.
- Platform security – online platforms include risk of cyber-attack and security risks from client information and fraud. Nesta in conjunction with Cambridge University, investigated into alternative finance and reported a shocking 57% of crowdfunding platforms saw a collapse due to malpractice and a high risk appetite to growth.
In order to address these risks, the FCA’s regulatory regime includes restrictions on minimum capital requirements, due diligence on platform members and restrictions on who can become a platform member, investment limits, disclosure and professional requirements. More detail on this can be found in the FCA handbook.
The crowdfunding model utilises technology to bring together wider opportunities for the supply of capital in a way which have never been realised previously. It is expected that with the right regulation and risk awareness crowdfunding will continue to bring fantastic opportunities to the market and continue to diversify and innovate across industries and sectors.