Alternative Finance is a recent phenomenon that is growing at a staggering pace. However, I still see too many platforms missing that Alternative Finance is not about the recipient of the capital (i.e. the entrepreneur or the individual borrower); it’s about the source (i.e. ‘the crowd’). Alternative Finance can’t be about funding what nobody else wants to fund. It has to be about funding what everybody wants to fund.
The beauty of Alternative Finance is that it gives real people like you and I access to opportunities that were previously only accessible to banks or experienced investors (debt, equity or any other investment instrument). This poses a real threat to the established players as we become the source of capital, not the banks. We are in charge of our own finances and what we choose to support with our hard earned cash. The potential of this shift in source of capital is tremendous and banks are just starting to wake up to it.
However have no illusions. Just because you can, doesn’t mean you should. Alternative Finance cannot be about providing capital to all those companies or individuals that banks and other experienced investors have turned down because they found them too risky. If it was, it would be called charity and that’s a (very different) industry that already exists.
There are many different types of Alternative Finance platforms such as lending to individuals or companies and buying equity (buying shares) in companies. It is easier to compare debt-based platforms with traditional means of lending than it is to compare equity-based platforms, so I’ll start here. When people lend money to businesses or people that are worthwhile, it replaces the middleman (the bank with the online platform), it provides cheaper access to capital for companies or individuals and hopefully better returns to investors. It removes fat and inefficiencies from the system and I quite like that. However it is essential that the risk / return profile is not changed significantly from what an experienced investor would get.
For instance, lending money to early stage companies that still have a reasonably high probability of failure is asking for trouble. The investor is exposing themselves to a high-risk proposition for a fairly limited upside (the interest rate, which is usually at best around 10%). If one in ten early stage companies goes bust, any lenders will be losing money. If none of the ten goes bust, the upside is only in the order of 10% or less. Not good as the probabilities are not in favour of the lender.
Comparing equity-based platforms with traditional funding is slightly more complex but it all boils down to one question: why on earth would you want to back a company that no experienced investor is willing to put their money into? Just like debt, the beauty of Alternative Finance in equity is about giving people like you and I access to the same opportunities the experienced investors want to invest in, not to give access to the opportunities that nobody else wants to touch.
Alternative Finance providers have to be better, more efficient, cheaper and more transparent than the established players in the market. For Alternative Finance to be sustainable, it has to look after the source of the finance: to cater for the ‘the crowd’ and ensure that they get a fair deal.
This is what Alternative Finance stands for: true democratisation of investment – giving people access to the investment opportunities that the professionals want to invest in.