Peer-to-peer lending platforms are experiencing explosive growth and the trend is set to gather momentum as start-ups bypass the banks, says James Codling of VentureFounders
The number of new businesses being created each year has been rising consistently and reached a record-breaking 581,173 in 2014 – an astonishing figure. Recent statistics from Companies House show that so far this this year a remarkable 204,075 start-ups have been launched and that total is climbing continually.
At the same time there has been a proliferation of new companies offering alternative sources of finance for start-ups and early-stage businesses that choose not to access funding via traditional routes. Certainly, there are now a number of different ways for entrepreneurs to secure finance.
One route to consider is taking on debt, and several peer-to-peer platforms have emerged in recent years as a real alternative to the banks. Their growth has been explosive, with peer-to-peer lending reaching £749m last year, according to Nesta.
The government has also been supportive here in response to the high-street banks reducing their appetite to lend to riskier, early-stage businesses in light of new capital adequacy rules bought in after the 2008 crash. In 2012, the government launched a scheme with the Bank of England enabling SMEs to borrow at a cheaper rate and in 2013 it set up the British Business Bank to create more effective finance markets for SMEs.
However, debt isn’t appropriate for the vast majority of early-stage ventures. They are more likely to be looking for longer-term capital, where financing and the support of experienced investors are viewed as being equally important.
In the past angel networks and venture capitalists have typically served this part of the market. Crowdfunding has emerged as a serious contender in recent years, in part driven by advances in technology, but also as a result of VCs moving away from this space to focus on larger deals and the angel networks not truly fulfilling their role in the market.
The equity crowdfunding market is growing at an impressive 161 per cent per annum. For entrepreneurs, the benefits of crowdfunding are manifold. Firstly, it allows them efficient access to funding: the process is transparent, straightforward and can connect businesses to potential customers and interested investors.
By raising funds this way, entrepreneurs are able to develop and interact with their support network of investors. These investors will potentially form the foundations of the company’s future success. Crowdfunding is also an interesting marketing tool for entrepreneurs, potentially raising the brand profile and boosting the overall value of capital raised.
For investors, there are significant incentives to crowdfund. It allows investors to support growing British businesses that are too small to be listed on the London Stock Exchange, without them having to commit significant amounts of capital. Investors feel empowered to make their own investment choices and decisions, and can benefit from generous government incentive schemes, such as the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS).
EIS and SEIS are designed to stimulate entrepreneurship by offering tax breaks for investors. Through EIS, investors in start-ups can invest up to £1m in any tax year and receive 30 per cent tax relief. And any gains made on the sale of EIS-qualifying shares are exempt from capital gains tax (if the shares have been held for at least three years).
SEIS covers the first £150,000 of external investment in a seed business. The scheme is popular with investors due to the significant tax breaks it affords. Investors can invest up to £100,000 in each year in SEIS-qualifying businesses. In return, and so long as they hold those shares for three years, they receive up to 50 per cent tax relief regardless of their marginal rate, no capital gains tax when they sell their shares, and loss relief at their marginal rate.
The surge in the number of start-ups encouraged by schemes such as EIS and SEIS has done much to support the UK recovery by boosting the number of jobs and driving economic growth. It is clear that the funding void left by banks for start-ups and fledgling businesses will continue to be filled by the alternative finance sector. As crowdfunding becomes more prevalent, there are ever more opportunities for individuals to support the growth of innovative companies. It is evident that this trend is only going to gather momentum.
James Codling is co-founder and managing director of VentureFounders