What’s Alternative Finance?

Alternative finance options can help businesses grow their operations – but entrepreneurs need to understand the implications of each possible source.

Entrepreneurs and small business owners have more options than ever when it comes to securing funding for their companies, but anyone looking for capital should do their research to make sure they’re approaching the right source.

While banks can still be a great option for some businesses, others may be better suited to partnering with a venture capital firm or launching a crowdfunding campaign.

“There’s a lot more that goes into these funding programs now, and it’s why most of the very early seed-stage funding doesn’t come from the banks,” said Jeremy O’Krafka, a professor with the Entrepreneurship and Small Business program at Seneca College, and the founder of MENTORnetwork.CA.

A lot of funding, especially for young entrepreneurs, is currently coming from programs that “take a much more holistic approach, in that you don’t just get the money – you get money but they kind of wrap their arms around you in terms of providing you mentorship, coaching (and) creating peer communities,” he added.

“There’s a lot of value in that; I think that’s one of the things that helps enhance the chances of success.”

Here are some of the of the more commonly used alternative finance options:

1. Crowdfunding:
Crowdfunding involves raising small amounts of money from a large number of people, usually through an online crowdfunding platform like Fundable or Kickstarter as well as on social media. It gives entrepreneurs the chance to get their pitch in front of a lot more people, which could both be investors and possible future clients. It’s also a lot faster than taking a pitch to individual investors – it’s on the web for all to see. Crowdfuding can be donation-based, where there is no financial reward for the contribution, but the cause itself is one the person feels is worth investing in – think fundraising for someone’s medical bills, to support victims of an earthquake or to bring back a popular TV series. Rewards-based crowdfunding, on the other hand, does offer an incentive for the contribution – usually a product or service. Equity-based crowdfunding, for its part, gives contributors equity shares in the company, making them part owners.

2) Peer-to-peer lending:
Peer-to-peer lending, or P2P, lets lenders and borrowers talk to each other directly, usually through online services that match them up for a small fee. The idea behind this type of financing is that borrowing rates will be cheaper, since there’s less overhead than a bank would have. It also means lenders get higher returns. The loans can come from unsecured lines of credit or secured business loans, as well as real estate loans or payday loans.

3) Venture Capital:
Despite being a healthy sector of the private capital market, venture capital is still considered a form of alternative finance in Canada. It tends to be ideal for companies looking to scale and those working in the tech sector. To capture the interest of a venture capital firm, a small business has to have a good management team, a useful product and a clear understanding of the market it’s hoping to disrupt. The company also has to be able to show its product or service will make money, since VCs like to see their investments scale up quickly. Venture firms offer connections and mentorships as well as capital, in exchange for equity in the business.

4) Third-party funding:
A small business seeking liquidity also has the option to turn to a third-party or online lender, such a FundThrough or Mogo Finance Technology Inc. These are companies that make cash available, in the form of a loan, to help people and businesses manage cash flow. A lender like FundThrough offers an invoice-funding service that will basically pay the invoice a vendor sends its client, to tide the vendor over until payment arrives. It looks at the credit worthiness not of the small business submitting the invoice, but rather the (usually) larger company being billed. When the invoice is paid out, FundThrough collects its payments, along with a fee. Mogo, meanwhile, offers loans to individuals, at varying interest rates, even if they have a bad credit history.

5) Loans and grants:
There are also many programs across Canada to help small businesses fund (and grow) their businesses, including lots that will match the entrepreneur with a mentor, because that increases the repayment and outcome rates. The Business Development Bank of Canada, as well as organizations such as Futurpreneur Canada and SheEO all help get businesses off the ground, and unlike banks, initiatives like Futurpreneur take your experience and track record into account, instead of simply looking at what assets you have to leverage against the loan.

The type of financing a company could – or should – go after will depend on the business’ profile, the personal history of its owners and their funding goals, but the various forms of alternative finance are becoming increasingly popular, and a big focus for financial technology companies that see a sector ripe for disruption.

“Particularly for young people, they’re walking into a job market that is completely different than it was a generation ago; there’s not the same full-time job opportunities,” says O’Krafka.

“Starting a business is one option that they have, but if left to their own devices, there’s a good chance that they’re not going to be able to figure that out. Having a program that provides them a little bit of seed funding … and having the structure of the mentoring relationship and the coaching that they provide means (they can get) somebody who’s been there before to talk them through what their options are.”

4 years ago