The internet has helped revolutionise the way entrepreneurs can finance their businesses. It has never been easier to get hold of capital to start a new business. For example, via the web, entrepreneurs now have access to capital through peer2peer lending.
Peer2peer lending is a way for individuals to lend and borrow money without the use of an official financial institution as a mediator. For the entrepreneur, this eliminates some of the restrictions normally associated with getting a loan. In addition, investors typically get a better return on their investments. Yet there are problems with Peer2Peer lending: for one, in the UK it isn’t covered by the official Financial Services Compensation Scheme, which guarantees your savings up to the value of £85,000. Furthermore, some peer2peer websites tend to downplay the risks involved (of which there are many). Ultimately, the borrower may not be able to pay back the investor.
Fortunately there are other ways to finance a new enterprise.
Invoice Trading is typically used by small or medium sized enterprises (SMEs) but really it can be used by any company, whatever its size. Invoice Trading occurs when an SME puts an invoice in an online auction and sells them individually or in bundles to the highest bidder. The seller then buys back the invoice after either 30, 60 or 90 days. The person or company that buys the invoice normally gets a fee which is how they make money. The advantage is that the SME can get quick access to funds which help with cash flow – something that is considered a luxury by most start-ups. It also means SMEs can instantly pay due invoices and avoid being penalised for not paying outstanding charges.
Crowdfunding is another example of alternative finance. Crowdfunding allows entrepreneurs to raise finance by asking a significant number of people for a small amount of investment. It is particularly popular on the internet as people can easily access millions of potential funders. There are three types of crowdfunding: debt, donation and equity. Debt crowdfunding is effectively peer2 peer.
Donation crowdfunding is when individuals can share their money with projects and charities they have a strong interest in. Investors do not necessarily receive a return (though sometimes receive a promotional gift or reward, such as priority ordering, if the venture is successful) but typically donate for personal rather than monetary reasons. The amounts donated can be as little as $5.
Equity crowdfunding happens when individuals invest in an unlisted company in exchange for shares or a small stake in that company or project. Therefore, if a company does well, investors reap the rewards. Equity crowdfunding is especially attractive in the UK because the Government offers tax relief through either the Enterprise Investment Scheme (EIS) or the Seed Enterprise Investment Scheme (SEIS).
Many small businesses access money through friends or family. This may be an easy means of acquiring capital but mixing business with one’s personal life can be problematic.
Angel investors are another way of accessing money and most are found among an entrepreneur’s friends and family. Angel investors are inclined to thoroughly research the company and market before investing to ensure they are making the right decision. They are likely to be focused on helping the business succeed and usually offer valuable contacts and professional advice. Securing an Angel investor would be, for many entrepreneurs, ideal.
In contrast with Angels, venture capitalists prefer to invest in businesses with long-term growth potential. Typically these tend to be more risky investments. Venture Capital normally comes from a group of wealthy investors, investment banks or other financial institutions. However, venture capitalists will usually require an input in company decisions. This removes the element of autonomy that many entrepreneurs desire.
The British Government has shown great support for SMEs. In the past, the Treasury has stated that access to finance for growing companies is the most important factor in facilitating economic recovery. Additionally, in last years’ autumn statement, George Osborne pledged £400m to extend Enterprise Capital Funds: government-backed venture capital funds that invest in SMEs. The Treasury also guaranteed up to £500m of new bank lending to SMEs so it is a good time to approach banks for investment.
On the 1st April 2014, peer2peer lending became regulated by the Financial Conduct Authority; therefore it is not as risky as it once was. However, there are many other means of raising finance: I urge entrepreneurs to do their research and find the most appropriate option for themselves and their business.