Alternative lending is a broad term used to describe the wide range of loan options available to consumers and business owners outside of a traditional bank loan. These alternative options are most commonly used when an individual or business owner cannot obtain a traditional bank loan for any number of reasons. Alternative lenders specialize in utilizing overlooked sources of collateral such as real estate or even outstanding invoices to secure the loan. They are typically more flexible than banks when it comes to repayment schedules and loan approval and often provide cash much faster than their traditional banking counterparts. The alternative lending industry is well-established and generally staffed by well-respected members of the financial services community.
Facts about small businesses
Financial crisis tend to hit small firms harder than large firms.
Small businesses were hit harder than larger businesses during the 2008 financial crisis, and have been slower to recover from a recession of unusual depth and duration. Small firms were hit harder than large firms during the crisis, with the smallest firms hit hardest.
Small businesses are critical to job creation in the U.S. economy.
Bank loans have historically been critical for small businesses.
Alternative finance is an umbrella term that covers a range of very different models from people lending money to each other or to businesses, to people donating to community projects and businesses trading their invoices. The distinctions between these models are important as they differ enormously in the types of people and organizations that use them, why they use them and the nature, form and amount of financial transactions that take place.
Peer to peer Business Lending: Debt based transactions between individuals and existing businesses which are mostly SMEs with many individual leaders contributing to any one loan.
Peer-to-peer Consumer Lending: Individuals using an online platform to borrow from a number of individual lenders each lending a small amount; most are unsecured personal loans.
Invoice Trading: Firms sell their invoices at a discount to a pool of individual or institutional investors in order to receive funds immediately rather than waiting for invoices to be paid.
Community Shares: This term refers to withdrawable share capital: a form of share capital unique to co-operative and community benefit society legislation. This type of share capital can only be issued by co-operative societies, community benefit societies and charitable community benefit societies.
Reward-based CrowdFunding: Individuals donate towards a specific project with the expectation of receiving a tangible (but non- financial) reward or product at a later date in exchange for their contribution.
Donation-based Crowfunding: individuals donate small amounts to meet the larger funding aim of a specific charitable project while receiving no financial or material return in exchange.
Equity-based Crowfunding: Sale of a stake in a business to a number of investors in return for investment, predominantly used by early-stage firms.
Pension-led Funding: Mainly allows SME owners/directors to use their accumulated pension funds in order to invest in their own businesses. Intellectual properties are often used as collateral.
Debt-based Securities: lenders receive a non-collateralized debt obligation typically paid back over an extended period of time. Similar in structure to purchasing a bond, but with different rights and obligations.
SME’s depend on alternative finances:
Cost of finance and regulation are important factors for SMEs considering alternative finance.
Online lenders, investors and borrowers worry about the potential effects of future legal restrictions. Although it would make borrowing safer, regulation could also raise expenses and increase waiting times
Staying true to peer to peer values:
Alternative finances are built on peer to peer values. Peer to peer borrowing offers to SME the opportunities most banks would offer, the only exception is the lack of rules that define them as these financial institution. As borrowing demands go up, the imposition of rules might lead to discomfort from lenders as they would view lenders as just another institution.
Holding the “hot” money:
In low rate environment, it is relatively easy to attract institutional money, but its reliability is untested when the interest rates are higher.
Keeping the customer they’ve got:
Loyalty appears to be high in alternative finance. Many users are returning into this service because it meets their needs. They problem seems to be with the traditional bank system who view them as a strong competition.
Cost of finance and regulation: This could lead to disinterest in the franchise. Lack of investors would affect the overall turn up of the industry.
Staying true to peer to peer values: if values of peer to peer lending are forgotten, most borrowers would lose interest. They don’t want to run businesses with bank like institutions. And alternative lenders offer that because of their consistency in staying true to their values. But as the sector grows, it might get hard to stay solid to these cores and this might affect the turn up too.
Holding the hot money: Alternative lenders have to learn to hold the institutional money that they give with low interest. As the interest rates go higher, the harder it is to hold these monies.
Keeping the customer they’ve got: Competition among alternative lenders and the traditional bank. The competition is also between two alternative lenders.
To cater for these problems, 1700+ companies have been founded in the sector, 638 funded in last 5 years, $21b invested in 2015/2016. Most Active Investors: QED Investors, Sequoia Capital, Victory Park Capital, 500 Startups.
CONSUMER LOANS: This includes online lending platforms offering loans to consumer for various purposes like point of sale finance, auto finance, education finance, housing finance. Since 2008, 694 companies have been founded that cater for this category of loans, with a total investment of $15B.
There are 5 subsections under this section.
Unsecured Personal Loans: Online lending platforms offering loans for any personal purpose. One example of a company that deals with unsecured personal loans is Lufax. Lufax was founded in 2011 in Shanghai. They are a peer-to-peer lender and financial-asset exchange company. As of January 2016, they got a funding amount of $1.2B from these companies: CDH Investments, Arbor Ventures, CICC, China Minsheng Bank, Guotai Junan Securities, Ping An Insurance, BlackPine Private Equity Partners, Bank of China Group Investment.
Asset Backed Loans: Online lending platforms offering loans secured against a collateral. A good example is Finova Financial founded in 2015 in San Francisco is a direct lender for car title loans. With a total of $52.5M funding from Metamorphic Ventures, 500 Startups, MHS Capital, Coventure, Alhamragroup. Another company is Weidai founded in 2011 in Hangzhou. They are a peer to peer lending platform in China. With a total funding of $152.2M from these investors: Shanda Group, Vision Knight Capital, HAKIM, ZSVC.
PayDay Loans: Online lending platforms which give loans for a tenure of 7 to 30 days. Wonga founded in London with a funding of $145M from these investors: Accel Partners, Greylock Partners, Balderton Capital, Meritech Capital, Oak Investment Partners, Holtzbrinck Ventures, Dawn Capital, Wellcome Trust, Oak Investment Partners, 83North.
Purchase Financing: Online lending platforms offering point of sale financing. Paypal Credit founded in Lutherville Timonium. They provide purchase financing options to consumers. With funding of $100M from: Amazon, Upfront Ventures, Azure Capital Partners, Kingdon Capital, Crosspoint Venture Partners.
Education Loans: Online lending platforms offering loans to students for education. A worthy company is CommonBond founded in 2011 in Brooklyn. They are an online lending platform for securing education loans. With funding of $$174.65M. Their major investors are: August Capital, Tribeca Venture Partners, Victory Park Capital, Barclays, Nelnet, DBRS, Macquarie Group, Moody, Nyca Partners, Social Capital.
BUSINESS LOANS: This includes online lending platforms offering loans to businesses for working capital, expansion, equipment financing, etc. With 556 companies founded over the last 9 years. The total funding of $5592B.
The loans provided are sub divided into 5 types:-
Term Loans: Online lending platforms offering loans to businesses for a fixed tenure usually more than a year. Funding Circle founded in London is a peer to peer lending marketplace for small businesses. They have a funding of $273M from Accel Partners, Index Ventures, Union Square Ventures, DST Global, Temasek, Ribbit Capital, Baillie Gifford, Sands Capital, Montage Ventures, Endurance Companies.
Working Capital: Online lending platforms offering loans to businesses for a tenure of less than a year, in order to meet day to day expenses of business. Kabbage founded in Atlanta. They provide working capital financing for small businesses. They have a funding of $240.81M. Their investors are: SV Angel, United Parcel Service, Mohr Davidow Ventures, SoftBank, ING, BlueRun Ventures, Western Technology Investment, Lumia Capital, Thomvest Ventures, Victory Park Capital, Recruit Strategic Partners, Guggenheim Partners, Scotiabank, TCW Group, Mavcap, Reverence Capital Partners, Santander InnoVentures.
Mortgage Loans: Online lending platforms offering loans for commercial mortgage. LendingHome founded in San Francisco. They provide alternative loans for residential mortgages. With a total funding of $109.3M. Their investors are: First Round Capital, Foundation Capital, Cowboy Ventures, Ribbit Capital, Renren, Colony Capital.
Project Loans: Online lending platform providing commercial project loans.
Purchase Financing: Online lending platforms offering purchase finance to businesses. Qufenqi founded in Beijing in 2014, they are an online microloan/installment plan provider for e-commerce purchases. They have a funding of $874M from these investors: Alipay, BlueRun Ventures, Kunlun, Kalends, Source Code Capital, ICH Group.
ENABLERS: Companies providing allied services to alternative lending platforms and to the investors on online lending platforms. A total of 116 companies have been founded in the last 8 years, with funding of $838M.
The enabler companies are divided into:-
Credit Scoring: Companies that use alternative data sources and machine learning algorithms to assess the credit risk of potential borrowers. Dimeng founded in Shenzhen. They are developers of systems for net loan platforms with a funding of $79M.
Investment Platform: Online platform which enables investors to invest in the loans on various alternative lending platforms and also maintain the investors’ portfolio. Orchard founded in New York City. They provide technology and infrastructure provider for marketplace lending, with these major investors:- Canaan Partners, Spark Capital, QED Investors, Thrive Capital, Thomvest Ventures, Victory Park Capital, Conversion Capital, Tom Glocer, Brooklyn Bridge Ventures, Nyca Partners, Social Leverage.
White-label Platform: Platforms that enable companies to start their online lending websites. Think Finance is an analytics and technology services for lenders. They were founded in Fort Worth with funding of $60M. The major investors are: Sequoia Capital, TCV, Victory Park Capital.
AGGREGATORS – These are the platforms which aggregate a number of online lending companies on one website, wherein the borrower can compare and choose where to borrow from. They usually have tie-ups with online lending companies and charge lead generation fee from them upon conversion of lead. There have been 110 companies founded in the last 9 years. The funding in this sector is over $246.1M.
A notable example is Bizfi situated in New York City. They are credit product aggregator. Their major investors are: Comvest Partners, Community National Bank, Metropolitan Equity Partners. They have a funding of $20M.
In conclusion, the advantages of alternative lending are summarized as follows:
Efficiency through technology and disintermediation.
Financial inclusion through better underwriting.
Greater transparency in the loan process
“Given current market trends, retail banking as we know it today will no longer exist by 2020. Even by 2015, almost all small retail banks will be struggling, and even some of the large banks will be trying to re-invent themselves as software companies as they are confronted by competition from more agile and technologically adept competitors.” Aaron Greenspan – CEO of Think Computer Corp November ‘10
The advantages to lenders and borrowers in alternative finance means success I s assured for the platforms with the vision, strategy and resources to exploit them. For borrowers, the low rates, convenience and transparency, coupled, for some, with the very fact that it is not a bank, will continue to attract the eyeballs and the ears of business owners. For lenders, the high returns and diversification offered by a new asset class will remain a magnet, even in higher interest rate environment. Those that do succeed will create high barriers to entry for new players as they will have a significant head start in brand, liquidity and operational infrastructure. The waters ahead are unchartered, but undeniably exciting.