The advent of financial technology, or fintech, has opened up a whole new space for individuals and institutions seeking alternate forms of finance. Unfortunately, traditional banking institutions are frequently out of touch with their financial services. Often, they need help understanding and meeting the demand for flexible, affordable, and innovative financial service options.
Alternative finance fills this gap. It has gained popularity and a loyal user base for the past decade, mainly due to its innovative and low-cost services. It also allows for rapid delivery of and enhanced access to banking services.
What is alternative finance?
While there is no single technical definition for alternative finance, it can describe any form of financial service operated or managed outside the corners of a traditional banking system. Within alternative finance is the fintech ecosystem comprising companies, processes, and technologies that aim to improve or transform the conventional functions in finance, such as consumer lending, financing, insurance, and payments.
Alternative lending for businesses
Individuals and small- and medium-sized businesses that face pushback or rejection from traditional banks have far better chances of obtaining financing from nonbank and alternative lending institutions. Much like traditional banks, nonbanks also engage in credit card and mortgage lending operations. Still, they are more capable of providing efficient and easier access to small business loans, even for those without good credit histories. They do this by leveraging artificial intelligence and machine learning for data gathering and risk analysis to sign up qualified businesses.
In a 2020 Oracle survey of 5,200 consumers from 13 countries, 40 percent believe they can benefit from improved personal and investment management by engaging with alternative financial institutions. Meanwhile, 30 percent of the customers surveyed who haven’t had experience with nonbanks expressed openness to engaging with one.
Similar to banking services, alternative lending has its risks. For instance, unlike traditional banks, alternative lenders are not required to meet the same strict regulatory requirements. Before engaging with an online financing platform, verify that it has a good reputation. Look up the business on Better Business Bureau and check reviews from neutral websites, not just testimonials on the business’ own website.
Trustworthy alternative lenders should be transparent about upfront costs, fees, and borrowing rates. Credible lenders also typically require tax returns, business debt details, personal financial statements, profit and loss statements, and personal guarantees. If an online small business lender guarantees approval with minimal effort in vetting your business, likely, they are not legitimate.
Peer-to-peer lending for small businesses
Peer-to-peer (P2P) lending, one of the successful by-products of alternative financing, provides an online platform where individuals or businesses can borrow money directly from investors. This effectively cut out banks as an intermediary. The platform sets the terms, such as the maximum loan amount, repayment schedule, and annual percentage rates. In some cases, the investors’ money is automatically allocated to several borrowers. However, investors can also choose the borrowers they lend their money to.
One of the popular P2P lending platforms is SoFi, which started as a student loan refinancing operation before reaching out to personal and mortgage loan markets. Another one, Kabbage, focuses on short-term business financing to increase the capital of small business owners or fund projects. OnDeck is also an online business lending platform that offers up to $250,000 loans to small- and medium-sized businesses.
Alternative financing through crowdfunding
Startups often face barriers to capital funding. While venture capitalists and angel investors play a crucial role in enabling startups to ramp up operations until they start generating profit, many entrepreneurs still fail to apply for limited funding due to a lack of trust and stiff competition.
This is where crowdfunding comes in. Crowdfunding involves financing a business venture or project by raising smaller amounts of capital from a larger pool of people. Online crowdfunding platforms not only help generate financing for startups but also allow entrepreneurs to understand the size of their target audience, test and validate their product offerings in terms of market demand, and gain insights from other industry experts.
Rewards-based and equity-based crowdfunding
Different crowdfunding methods have emerged since rising to prominence after the 2008 financial crisis. Rewards-based crowdfunding involves raising capital from a group of individuals who, in turn, receives gifts or perks from startups for their pledged amounts. Kickstarter is an example of a rewards-based crowdfunding platform.
With Kickstarter, entrepreneurs or project creators sign up for the online crowdfunding platform and submit the details of their projects or businesses. They must specify their funding goal and set milestones and deadlines. If people are interested in the project’s outcome, they can pledge money. Depending on the pledge amount and the project creators’ preferences, the rewards can be as simple as a thank-you note. However, larger projects with significantly higher funding goals can offer extras such as personalized rewards, pre-order priority, and discounts on future purchases.
In the case of equity-based crowdfunding, entrepreneurs reach out to potential investors who want to invest capital into a project or business venture in exchange for equity or a share of the company. Individuals with high net worth seek startups with scalable business models, expecting to generate significant returns on their investments. SeedInvest Technology is a popular crowdfunding platform that has raised more than $500 million, helping over 250 startups fund their ventures.