By Chris Hancock on 31st July 2017
Whilst the growth of the alternative finance industry should be applauded, with over £11 billion transacted through P2P platforms in the UK alone, according to AltFi Data, the sector needs to keep innovating in order to continue to take advantage of developing technologies and changing market conditions.
Finance technology businesses, which have innovation in their heart at their core, are able to develop new products, such as crowdfunded Venture Debt, as they are more adaptive to new market conditions and more agile in their approach to developing products and processes.
Venture Debt, first introduced on Crowd2Fund in May of this year, allows earlier stage businesses which are revenue generating, but not profitable yet, to access debt finance, rather than being forced to sell equity in the company at a low valuation and lose control.
The size of the global Venture Debt market is currently predicted to be worth $3.9 billion annually; there are currently no crowdfunding platforms offering Venture Debt to businesses. The US is currently leading the Venture Debt market, however, it is mainly serviced by institutions.
Another indicative sign of the debt market maturing is that larger, more established companies are seeking debt instead of equity. A recent example is SoundCloud, which raised $70 million in Venture Debt earlier in the year, to complement its equity venture funding. With crowdfunded Venture Debt, the same principles can be applied to smaller deals and the SME marketplace.
Venture debt crowdfunding is made possible with enhanced due diligence procedures, used to assess the creditworthiness of business. The approach we take at Crowd2Fund is more thorough and less prescriptive than traditional credit assessments. The areas of due diligence on which the focus is on include debt management team reviews, company affordability modelling, structuring exercises and softer checks that include social media profiling and social media positivity scoring. A much deeper understanding of the borrower is needed by the credit assessment team in order to make a decision.
Combining all of these different sources builds up a more accurate picture of a company’s ability to service debt efficiently.
As businesses suitable for this type of debt have less trading history, affordability checks are more weighted on future forecasts than historical performance. This makes the reliability of forecasts somewhat riskier, and means that extra onus is put on questioning the assumptions on which they are based. Additionally, it can also be irresponsible to laden early stage companies with debt so the way in which the debt is structured is important.
Consideration must be given to both the businesses being vetted, alongside the potential investors in Venture Debt vehicles. Platforms have a responsibility to help facilitate an equitable and sustainable financial ecosystem which benefits the wider economy.
Enhanced due diligence places greater emphasis on the management team’s capabilities and experience. Team members are interviewed in depth in order to understand their approach and business model in more detail. The capability of management teams is based on previous experience and success, including whether they have successfully built and scaled high growth businesses and startups in the past.
The profile of businesses suitable for Venture Debt on platforms such as ours will have existing customers and a strong brand, therefore, businesses offering crowdfunding rewards to an already captive and engaged audience increases their popularity.
This can help attract investment as well as offset risks for individual investors.
Firms are also encouraged to promote the opportunity to their customer base as customers are more likely to invest due to the existing relationship with the business.
In order to further protect investors’ interests, more robust legal structuring and security is often required. Security is often necessary to reduce risk for investors, but can also allow businesses to access Venture Debt at a lower rate than an unsecured loan. Whilst these processes are relatively time consuming, this highly innovative and bespoke credit approach opens up this new potential debt market that offers many benefits to entrepreneurs and the wider economy.
AltFi is returning to Amsterdam for its second annual Summit in the city. The inaugural event last year was a roaring success, with key figures from across Continental Europe's alternative finance and digital banking sectors highlighted. These included Jeroen Broekema, managing director of Funding Circle Netherlands, and Mieke van Engelen, head of innovative partnerships at ABN AMRO's standalone lending platform, New10.