What is Alternative Financing?

Nowadays, entrepreneurs and small business owners have more options when it comes to securing funding for their businesses, but not everyone that is looking for capital runs a detailed research to understand that they are approaching the right source.

Most people will think that banks are still the great options to get capital for some businesses or partnering with a venture capital firm. However, there are a lot more funding options in the market where entrepreneurs manage to get funded even from the very early seed stage.

So, what is alternative finance? It is a broad term, encompassing many types of finance solutions. It refers to forms of finance that are outside the institutional finance system of banks and capital markets. ‘Fintech’ is the ecosystem within alternative finance made up of companies, technology, and processes that aim to improve traditional methods of finance in categories. Some of the examples are such as:

a.) Equity Crowdfunding 

b.) Peer-to-Peer Lending

c.) Security Token Offering

d.) Private Fund

e.) Invoice Factoring

f) Supply Chain Financing

Small amounts of money are raised from numerous investors, meaning a solid business plan and confident pitch are required to convince potential investors. Essentially, equity crowdfunding offers the company’s securities to a number of potential investors in exchange for financing. Each investor is entitled to a stake in the company proportional to their investment.

Unlike conventional capital raising methods which primarily rely on investments from a small group of professional investors, equity crowdfunding targets a broader group of investors. The main idea of equity crowdfunding is to raise the required capital by obtaining small contributions from a large number of investors.

In Malaysia, the crowdfunding process is carried out on specialized online platforms which are approved and regulated under Securities Commissions Malaysia since 2015.

To understand more about Crowdfunding, click here.

Peer-to-peer lending is a form of direct lending of money to businesses without an official financial institution participating as an intermediary in the deal. P2P lending is generally done through online platforms that match lenders with potential borrowers. 

Peer-to-peer lending is a fairly straightforward process. All the transactions are carried out through a specialized online platform. In Malaysia, a peer-to-peer lending platform must obtain approval from the Securities Commission and operate under regulated laws. The steps below describe the general P2P lending process:

1. A potential borrower interested in obtaining a loan completes an online application on the peer-to-peer lending platform.
2. The platform assesses the application and determines the risk and credit rating of the applicant. Then, the applicant is assigned with the appropriate interest rate.
3. When the application is approved, the applicant receives money from the investors based on his credit rating and assigned interest rates.
4. The applicant is responsible for paying periodic or monthly interest payments and repaying the principal amount at maturity

The company that maintains the online platform charges a fee for both borrowers and investors for the provided service.

Security Token Offering shares similarities with both initial coin offerings (ICO) and traditional securities like initial public offerings (IPO). This unique crowdfunding strategy combines the efficiency of blockchain technology, with the legal protections found in standard securities offerings. STO is linked to an underlying asset such as Shares, Bonds, Real Estate, or other funds, This form of crowdfunding creates a safer investment climate for potential investors. In return, the security token holders are entitled to profit sharing, dividends, voting, and other benefits.

Therefore, securities token offerings distribute securities. These tokens are fungible, tradable financial instruments with a fixed monetary value such as part of the property or a company shares. Securities tokens are not traded on regular token exchanges. Exchanges that want to offer to trade in security tokens must comply fully with the regulations, including extensive research on symbolic listings, data exchange, and onboarding procedures for investors. This is how security tokens are traded on specialized exchanges. Companies that digitized shares and issue as tokens on the blockchain will issue a digital share certificate to their investors. Each token will represent one share in the company.

Private fund is an alternative investment class and consists of capital that is not listed on a public exchange. Private equity comes from high-net-worth individuals and firms that purchase stakes in private companies or acquire control of public companies with plans to take them private and delist them from stock exchanges. A private equity fund had Limited Partners (LP), who typically own 99 percent of shares in a fund and have limited liability, and General Partners (GP) who own 1 percent of shares and have full liability. The latter are also responsible for executing and operating the investment.

The private equity industry comprises institutional investors such as pension funds, and large private-equity firms funded by accredited investors. Due to private equity entails direct investment which often to gain influence or control over a company’s operations.

The minimum amount of capital required for accredited investors can vary depending on the firm and fund. Some funds have a $250,000 minimum entry requirement, while others can require millions or more.

Invoice factoring is a way for businesses to fund cash flow by selling their invoice to a third party (a factor, or factoring company) at a discount. Invoice factoring can be provided by independent finance providers or by banks.

The business client enters into an agreement with the factoring company whereby the company will manage their sales ledger and credit control on an ongoing basis for a fixed period (based on the term of the contract like 12 months or 24 months). In return, the factoring company advances some funds upfront when the business client sends an invoice to a customer – typically 70%-85%. When the end customer comes to pay, the factoring company collects the debt and makes the remaining balance available to the business client, minus their fees.

For a fee, factoring companies can unlock funds tied up in unpaid invoices so that your business receives funds without waiting for customers to pay. This makes cash flow management easier for businesses that use factoring. Many factoring providers will manage credit control where business no longer needs to chase customers for invoice payment which helps to save a lot of admin time.

Supply chain finance is a form of supplier finance in which suppliers can receive early payment on their invoice. It is almost the same with Invoice Factoring but the difference is supply chain finance is set up by the buyer instead of by the supplier. Another key difference is that suppliers can access supply chain finance at a funding cost based on the buyer’s credit rating, rather than their own. Supply Chain Finance benefits on dynamic discounting in which the buyer funds the program by enabling suppliers to access early payment on invoice in exchange for a discount. 

The buyer will enter into an agreement with a supply chain finance provider and will then invite its suppliers to join the program. Some supply chain finance programs are funded by a single bank or finance provider, while other programs are run on a multi-funder basis by technology specialists via a dedicated platform. Once a supply chain finance program is up and running, suppliers can issue their invoice to the buyer with payment due within a certain number of days (30 days, 60 days, 90 days). Buyer will then approve the invoice for payment. Supplier will request the supply chain finance provider for early payment based on the invoice. Then, the funder will send payment to the supplier with a small fee deducted and buyer will only pay the funder on the invoice due date.

Supply chain financing benefits both suppliers and buyers in optimizing their working capital and also strengthening relationships.