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Market opinion | Alternative financing models | Jannah Patchay


sophisticated new models to lift the alternative financing sector to a new level and offer a viable alternative to the traditional model in which banks act as intermediaries by taking deposits from savers and lending to borrowers. At first glance, they may appear to bear little resemblance to their antecedents. However, a closer inspection reveals that the market challenges both faced by and addressed by the newcomers are very familiar to the traditional market operators.


Return on investment Fundamentally, every investor wants a return on their investment. Preferably a guaranteed return – witness the enduring popularity of bonds and fixed-term deposits with savers – but a higher level on risk may be acceptable if they deliver higher performance. The new breed of platforms can deliver the goods but in slightly unorthodox ways. For example, investors in a company wishing to take a new product to market and seeking funding via Kickstarter do not receive equity, nor do they receive any form of repayment. However, they are often the recipients of the first batch of product. This creates a virtuous cycle for the start-up, which is guaranteed not to be left with a mountain of unsold stock, as well as a source of free marketing (consumers who like a product will tell their friends about it). Funding Circle, which matches savers to a


portfolio of businesses wishing to borrow, offers returns from 6.3-9% depending on the borrower’s credit profile, an impressive step up from typical savings account rates that is also well below typical business loan rates. CrowdCube and Seedrs both offer a more


traditional route for investors through an equity stake in the business, through which dividends can be paid and exit via a sale achieved.


Liquidity In any market, liquidity is essential – the ability for investors to dispose of assets and take P&L in cash. Whilst these instruments are hardly going to be as liquid as those listed on a main market, this is a well-known challenge for SME markets and


Best Execution | Summer 2013


both lending and equity-based players are taking steps to address this. Solutions include provision of a limited secondary market function whereby investors wanting to exit may re-sell their holdings to another platform member. Innovative product structuring can help to encourage liquidity. Funding Circle allows investors to manage risk and diversify their portfolios across many small loans, and to auction these micro-loans off.


Investor confidence While investors may have different risk appetites, in order to continue attracting investors, a platform must be able to demonstrate a certain level of success on the part of the businesses it introduces to them. Here again, the model of investor-who- is-also-customer reinforces the growth prospects for a business. Some platforms pre-screen SMEs who come to them for funding, while others take the view that market forces know best and allow any business to advertise itself, leaving it up to the investors to judge the relative merits of a business model. Most encourage businesses to provide extensive and detailed documentation to support their bids for financing, including publication of business cases, accounts and financial projections.


Additional services / market infrastructure It is simply not sufficient to facilitate an equity sale transaction resulting in the investor holding a number of share certificates and the business holding some cash. Seedrs now acts as a custodian for shares, manages the payment of dividends from businesses to investors, and provides a secondary market for investors wishing to exit – a full-fledged market in miniature. This is the sort of value-add service that lowers the barriers to entry for investors, by making it easy and transparent for them to use the platform. While their business models are new, the


market structures evolving around the new breed of alternative financing platforms are familiar. They may be creating new opportunities for historically neglected market participants – start-ups and ordinary savers – but the shapes and patterns follow a well-worn, tried and tested path. n


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