A legal look at alternative funding initiatives

For many developing companies, traditional forms of funding are still closed off. As for the new players in the funding landscape, there are commercial and legal issues which may arise and must be considered before business owners sign on the dotted line for these loans.

Taking a look at some of the key initiatives, here is a round-up of what you need to know:

Start-Up Loans

With programmes like BBC3’s ‘Be your own boss’, featuring Richard Reed, the co-founder of Innocent Smoothies, young people are increasingly being encouraged to forgo the usual route to employment and go it alone. The government has recognised this entrepreneurial zeal and in May 2012, the Start-Up Loans Company was launched. Aimed at encouraging young people aged between 18 and 24 to start their own business, the scheme provides mentoring and offers loans of up to £2,500. It has received over 2,000 applications since its inception.

The scheme has been criticised by some for burdening young people with debt, but realistically a new business is rarely established without borrowing money. From a legal perspective, the scheme is fairly straightforward, with the funds provided by the prince’s trust or a regional loan provider (delivery partner) who the contract will be with. The loan must be paid back within three to five years at a fixed APR, currently at six per cent.

So what are the drawbacks? First and foremost it’s a personal loan, so the entrepreneur is personally liable to repay it. Secondly, £2,500 does not go very far, but if there is more than one entrepreneur involved with the business they can each take a Start-Up Loan. In addition to the loan, entrepreneurs receive business support and mentoring. 

Enterprise Capital Funds

These funds splice government funding and private investment to provide equity finance to SMEs. Businesses should carefully investigate the various fund managers, of which there are 11, to find the right match for their company.

For instance, MMC ventures is focussed on established, strong management teams that operate in financial services, business support services, digital media and consumer sectors. Passion capital works with technology start-ups. ECFs can provide up to £2m of funding to SMEs, but there are various qualification criteria. 

Peer-to-peer loans

“Never a lender or borrower be” goes the saying, but as of June this year, it is estimated the amount provided by peer to peer loans topped £250m. The government has pledged £100m to support these lenders, with Funding Circle in particular lending from a peer-to-peer platform to businesses.

These loans range from £5,000 to £500,000 and include unsecured loans, secured loans and large asset finance loans. The level of security required will depend on the value and the purpose of the loan, a personal guarantee may also be required and other trading criteria may be applicable.

The quick and simple nature of these loans, not to mention the competitive rates and the distance from banks and banking culture that they represent may appeal to many SMEs. However, it is essential business owners do exercise a degree of caution. While most of these lenders will be governed by the consumer credit act, which ensures general fair trading and fraud legislation, they are not yet regulated by the FSA. This form of lending is widely considered as being still in its infancy and it is thought that any attempt to introduce strict legislation would stunt innovation. Self-regulation and membership of finance associations will instead be encouraged as part of the government’s move to cut red tape and promote growth for SMEs.

However, for prospective lenders looking at peer-to-peer loans as a form of investment or savings vehicle, this lack of regulation and protection increases the risks associated with making such loans. Unlike where savers place their money with banks who then lend it on to borrowers, there is no guarantee that they will get their money back, as the financial services compensation scheme, which protects bank savings of up to £85,000 per bank, for each saver, does not cover peer-to-peer platforms.

Deviating from traditional forms of bank finance inevitably encounters a new form of risk. But by ensuring you are aware of all these potential financial and legal hazards and taking the necessary precautions, there is a whole new world of funding being developed out there which hopefully will ensure that SMEs’ blood keeps pumping.

Neale Andrews is a partner at Mundays and leads the firm’s corporate and commercial team.

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