Alternative Financing and its advantages
Alternative financing has become an increasingly popular option for small and medium-sized businesses in recent years and is now considered a formidable and evolving competitor to traditional financing solutions.
This growth in popularity is a natural result of a long period in which businesses have sought flexible and dynamic solutions in financing processes.
Alternative financing has thus responded to unmet needs in the market by incorporating cutting-edge technology in building online platforms to attract working capital.
The actual challenges of the Alternative Financing
In the current context, where significant increases in interest rates are a usual topic in financial publications, traditional creditors (banks, NBFIs) tend to be conservative in granting loans to businesses, tightening access conditions. Also, SMEs do not always have the necessary guarantees to obtain bank loans.
These restrictive measures specific to traditional financing products are motivated by the need to actively manage default risks, which are generally increasing in this unstable economic environment.
As a result, SMEs that turn to traditional financiers often face time-consuming credit applications and high loan rejection rates.
What is alternative financing, and how does it work?
Essentially, Alternative Financing refers to the channels, processes, and financial instruments that have emerged outside of the traditional financial system.
The most well-known types of alternative financing include:
- factoring
- peer-to-peer loans
- equity crowdfunding
This type of financing has reconfigured the market for loans dedicated to SMEs, facilitating access to the working capital needed for businesses. In practice, it represents a different approach to the lending process, designed to improve the customer experience.
Unlike traditional lending, which focuses on borrowing loans, lines of credit, and other products offered by financial institutions, often through an actual visit to their agencies, the alternative financing process is built around data.
The application process for a traditional lending product often involves a cumbersome process for SMEs seeking financing. They must have income and expenditure reports available, sometimes bear the cost of financial audits, gather financial documents and organize them for analysis, and manage their current debt situation and available guarantees in order to get a good credit score.
On the other hand, in the case of Alternative Financing, the most important aspect is that you can avoid bureaucracy.
The potential of the Alternative Financing Segment
The advantages of using alternative financing tools by businesses have led to significant recent growth in this segment, maintaining its trend for the next 5 years. Thus, globally, the value of transactions related to this segment is expected to reach approximately 6.69 billion USD by the end of the current year.
Also, the estimated annual growth potential for the period 2022-2027 is around 5%, leading to an anticipated total market value of the alternative financing segment of 8.56 billion USD (Source: statista.com).
The role of technology used in Alternative Financing
Alternative Financing platforms use a variety of databases that bring together financial and non-financial information from a multitude of sources, some of which can be unstructured. These are used together with traditional data to analyze the risk associated with a financing request.
For example, in the case of an online factoring request, technology integration allows the use of a fast and efficient credit scoring tool. The analysis of alternative and traditional data of SMEs applying for the financing of bills issued to their clients provides detailed information that helps both SMEs and investors alike:
- Investors can make accurate, calculated, and fast decisions regarding the financing risk of bills;
- SMEs have increased chances of financing due to the reduced risk and transparency obtained from financiers.
The main benefits of automating processes
There are numerous in the use of technology by alternative financing platforms, but among the most important ones we mention:
- Less bureaucracy
The first and probably most obvious advantage of digitalization is a significant reduction in bureaucracy.
Thus, while accessing traditional products involves a lot of bureaucratic aspects – such as preparing a whole folder of printed documents and financial reports – accessing alternative financing involves a simple process of completing an online profile and uploading the invoices in electronic form.
- Higher approval chances for funding in a faster time frame.
Automated data verification generates a quicker response for funding. By using varied sources of information, risk analysis can go into more detail than a simple credit score.
Considering the type of clients (mostly SMEs), as well as the relatively short term for which funding is granted, it is evident that the funding process becomes much simpler and direct.
As a result, in most cases, the response regarding funding approval can be obtained in just 24 hours.
- The advantage of a marketplace in alternative financing
In addition to the previously mentioned benefits, the use of technology comes with another essential advantage: it allows the creation of a context in which SMEs can access funds from multiple sources.
Within an alternative financing platform, applicants can obtain offers for funding their invoices through an auction mechanism from banks, NBFIs, and private investors, without the need to contact each potential financier.
The entire process takes place online, so representatives of SMEs no longer need to physically visit multiple agencies to identify an adequate financing solution. Instead, they can opt for the best offer obtained in the auction, from the comfort of their own office.
When is Alternative Financing recommended?
Traditional financing may remain an option when the business needs a significant, complex, and long-term loan.
However, if we are talking about financing working capital to boost rapid business development, capitalize on opportunities, or manage immediate cash-flow challenges, then Alternative Financing should be the natural choice for SMEs.