Monday 29th Oct 2018
Alternative Finance Explained: Jargon Made Simple
These days, start-ups and established businesses alike have a whole host of options to choose from when it comes to funding. There are many alternative lending products that work in a different way to the traditional loan, and it can be tricky to know exactly what they all mean, let alone how to choose between them. In order to remedy this, we’ve drawn up a list of some of the terms you’re most likely to encounter, with an easy-to-understand explanation of what they all mean.
Crowdfunding is one of the more recent developments in the world of finance, brought about primarily as a result of the internet becoming the main tool for businesses to find new funding options. At it’s core, it is very simple indeed. Rather than getting your money from one provider, or a handful of investors, your pitch can be financed by hundreds or even thousands of individual backers in exchange for future products, incentives or shares in the company. Kickstarter is one of the more famous platforms for this.
Hire purchase is most commonly used for vehicles, but can actually be used for many different assets, including things like large items of machinery. When a contract is taken out, you have the use of the asset for the duration of the period, paying a fixed sum at regular intervals (usually monthly), and then at the end of the agreement, the asset belongs to you. There’s usually a deposit to pay too.
For many businesses, funding is required because of difficulties in cash flow. Invoice Finance seeks to remedy this by using invoices as collateral, or by selling them. In simple terms, once an invoice is raised, the provider will pay the borrowing company a portion of the value of the invoice (up to 85%). Once the invoice has been paid to the creditor, you receive the remaining value of the invoice, less the relevant fees and interest. This is a particularly attractive option for those who have a well functioning business, but cannot realise the cash owed to them quickly enough.
There are also a couple of variations within Invoice Finance, and namely they are Invoice Factoring and Invoice Discounting. The primary difference between them is that Invoice Discounting is entirely confidential as you the client maintains the credit control, whereas Invoice Factoring involves the provider handling the collections process, making them known to customers.
A Personal Contract Purchase is similar to hire purchase, and is almost always used as a way of financing vehicles, but does differ slightly. At the end of the agreed period, rather than owning the asset automatically, you are able to pay a final fee to do so. This fee is agreed at the beginning of the contract, and is decided by the projected value of the vehicle at the end. As a result, PCP payments are usually lower each month, though the initial deposit can vary.
Peer-to-peer lending is another option that has expanded enormously with the advent of the internet. It’s in a similar spirit to crowdfunding, except that it aims to pair up businesses or ventures with those individuals or groupings looking to invest. There are many platforms that facilitate this process, most of which are online. This is a good option for those looking for an investor who is actively looking to help a small business, or for projects that may not have the mass appeal of crowdfunding.
Overdrafts are very commonly used, but still represent an alternative to the usual loan. With an overdraft, a lender will give you an agreed credit limit that you can use and pay back as you choose. There is a fee for using this facility, which often scales with the size of the overdraft. This is a good option for businesses that believe they may be able to pay things back early, and require flexibility. However, it can soon prove insufficient for a growing business, which is why more alternative methods have become popular.