The research, ‘Financial innovation today: Towards economic resilience‘ launched in Leeds today and funded by Friends Provident Foundation, looks at the qualitative data drawn from interviews with alternative finance practitioners to understand better where they are coming from, where the sector might be going, and why we might all want to get involved in alternative finance.
Here we summarise some key points of interest:
1. Alternative finance is going through rapid growth
The UK ‘AltFin’ sector is growing fast, worth £3.2bn in 2015 – a five-fold increase on two years previously. This is still a small part of overall UK financial services, but in some sub-sectors the alternative is becoming significant. Although banks lent over £50bn to SMEs in 2015, 14% of new loans to small businesses came via alternative finance platforms. In the community enterprise field, the £61m raised through community shares last year is a significant sum. And while it is smaller, donation-based crowdfunding is the fastest-growing part of alternative finance.
The basic business model is that funders (individuals) transfer money to fundraisers (individuals or organisations) through an online platform, which charges fundraisers a fee for this service. Beyond this there are many different financial arrangements, all with different implications for funders and fundraisers. Peer-to-peer loans, bonds and debentures have to be repaid with interest. Community shares are regulated to keep dividend payments low, but give shareholders a say in the governance of the fundraising organisation. Donations are the simplest model, with companies suggesting that offering ‘in-kind’ or symbolic rewards to donors helps raise money.
2. AltFin is ‘democratising’ finance
One thing that would-be fundraisers should bear in mind is that, no matter what financial model you adopt, this is not ‘easy money’; you can’t just put your project online and wait for the cash to roll in! Like any other fundraising drive, you have to promote relentlessly and creatively. However, this can bring many non-financial benefits in the form of engagement with supporters, stakeholders, and often the ‘end-user’ as your intended market.
This engagement with the public is in fact at the core of alternative finance. Many interviewees saw themselves as democratising finance through giving the general public greater access to a range of financial activities that were previously the preserve of a small elite. This is not full financial inclusion, as participation in online alternative finance platforms requires access to the internet and a bank account. Nor do most models as yet give funders much democratic say in the organisations they fund (community shares are a notable exception here). But in general, AltFin gives fundraising organisations an exciting opportunity to connect more directly with the people that fund them.
3. The role of alternative finance in regeneration
So what makes the funders tick? Social and environmental benefits are key priorities for some, and platforms such as Crowdfunder, Ethex or Abundance have raised millions in donations for community projects or loans for renewable energy. Many funders do want a financial return, but are also interested in seeing their money do something worthwhile. The idea that alternative finance funds the ‘real economy’, rather than abstract financial speculation, is widespread across the sector.
In practice this means that finance for small businesses is a major focus of many platforms. And while it seems that ‘real’ can also mean property (with ‘PropTech’, buy-to-let crowdfunding, growing fast), funders’ appetite for bricks-and -mortar might also be an opportunity for community regeneration and social housing projects to tap into. Some are already exploring this, with organisations like London Community Land Trust and Leeds Community Homes looking to community share issues to raise money.
Many funders are also interested in investing in local initiatives. Alternative finance can help to circulate money within local areas, which can be empowering for small businesses and community groups. But there are limits to what can be raised in one locality – particularly a factor for larger projects. And a very local focus might exacerbate existing inequalities, a risk highlighted by the dominance of London and the south-east in alternative finance. Instead, the sector’s greatest potential could be to build a more decentralised financial network: reducing regional inequalities and making it easier for smaller organisations to fundraise and engage beyond their local area.
4. As the mainstream gets on board, can alternative finance remain innovative?
The AltFin practitioners we spoke to were clear that the sector would continue to grow: but we argue that how it does this is vitally important. In search of more funds, alternative finance companies are striking funding deals with larger, mainstream institutions, either alongside or independent of individual ‘retail investors’.
In lending and equity, established institutions see alternative finance as an efficient way of reaching new markets and making a good return. In the short term this should help the sector make more funds available for small businesses. But looking to the longer term, there is plenty of debate about whether it will ultimately restrict the sector to what the Finance Innovation Lab calls ‘status quo innovation’ – a more efficient way of doing the same thing – rather than striving for truly ‘transformative innovation’, where the mainstream finance becomes more democratic and people-driven.
Public and third sector institutions are arriving too: Crowdfunder has led the way in working with local authorities to fund community projects, often through match funding deals, but there is scope for much more; Greater Manchester Combined Authority has put £2m into MarketInvoice to help the region’s small businesses with cashflow issues; and Abundance has partnered with Swindon Council to build a new local renewable energy project. The future relationship between the alternative and mainstream finance appears still to be up for grabs.
We think government can help, by providing guarantees that lower the risks to individual funders, but a crucial factor in the future of alternative finance will be sustaining the civil society organisations that promote financial reform (e.g. Finance Innovation Lab, Move Your Money, New Economics Foundation, Positive Money and more). They have a vital role to play in protecting the moral integrity of the AltFin sector, perhaps through establishing a set of standards, and definitely by improving public understanding of economics and finance.
All this will be needed if AltFin is to fulfill its radical potential to build a better kind of financial system.