Alternative finance 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 such as:
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Fintech stands for financial technology. Originally, the term referred to the back-end technology that was used in the traditional financial sector, but since the start of the 21st century, the term has expanded to include new technological innovations in the financial sector, such as cryptocurrencies and online lending platforms.
Simply put, fintech applies technology in order to improve financial activities.
Fintech companies are often startups or more established financial and technology companies that are trying to improve upon traditional forms of finance. North America has the greatest density of fintech companies in the world, closely followed by Asia (Investopedia).
Fintech companies are the providers of financial technology that enables transactions for consumers and businesses, or helps other companies manage the financial aspects of their operations. Fintech firms offer a wide array of products and solutions such as:
Fintech is often thought of as a recent phenomenon, which brings to mind technological innovations such as Bitcoin or mobile wallets. However, technology has played a key role in the financial sector for a long time.
Fintech technically dates as far back as the 1950s, when credit cards were introduced to ease the burden of carrying cash. It has been evolving ever since, with the introduction of ATMs, an electronic stock exchange, mainframe computers at banks, and the rise of the Internet, allowing for e-commerce and financial services across multiple devices. Have you ever taken a photograph of a paper check to deposit it into your account? That’s a recent fintech innovation too!
A fintech company is a financial company using technology to innovate upon existing institutional financial products. Generally, fintech innovations work to improve upon specific areas of a financial product, up to and including the speed of transactions, security, accessibility, cost, and the overall user experience. These companies typically consist of two core teams, with the engineers on one side and the financial analysts on the other side.
There are multiple business models that fintech companies use to earn revenue. The most common ones are listed below.
Similar to a traditional broker, fintech companies receive a fee or commission for facilitating a transaction. Here are some examples:
These are different from brokerage fees because they are not dependent upon transactions to generate revenue. For example:
Some insurance and lending marketplaces receive a commission for sending customers to partner businesses. The fee can be paid out based on traffic, leads, or conversion.
There are four main categories of users: 1) consumers; 2) business-to-consumer applications 3) business-to-business applications; and 4) the clients of financial services companies.
Fintech solutions also provide opportunities for groups that were previously underserved – these are consumers who have limited or no access to traditional banks and financial services.
Fintech is popular, both in headline news and also as measured by growth in the sector, because of two core shifts in the market. The “sudden” emergence of fintech (growth compared to other areas of startup innovation) can be attributed to developments in technology and a shift in user adoption of digital financial products.
Fintech is growing in popularity because access to technology has evolved to a place where smaller companies are able to offer competitive products. Financial products are no longer exclusively offered by traditional financial institutions. Consumers using mobile apps or the web now have instant access to their finances and don’t have to visit bank branches or wait on hold on the phone. Fintech has offered consumers and businesses the option to take charge of their own personal financial decisions at any time they choose.
Fintech innovation matters because it is providing financial access to underserved markets that went unaddressed in the traditional financial ecosystem. For example, fintech has made access to capital easier in developing countries and creates new opportunities for “under-banked” consumers and businesses who previously had few options to access credit.
For small businesses, fintech has not only made access to capital faster, but possible. Historically, 69% of small businesses have fallen into the “under-banked” category of borrowers, meaning they did not receive the full amount of credit they needed to grow (SBCS).
For everyday consumers, fintech has made it easier to manage finances and have access to financial products and services at a much lower cost and with greater convenience.
While there are concerns that the fintech landscape is less regulated than the traditional financial services industry, fintech companies are still bound by many of the same obligations as their institutional counterparts.
For example, many fintech companies and federally-regulated financial institutions have partnered up to improve back-office functions, such as settlement, clearing, and loan approvals. There are also fintech companies that exist outside this regulatory framework, but they still have to comply with certain federal and provincial/state regulations that apply to the entire financial services sector.
As with any new industry, regulation in fintech will continue to evolve over the next few years in order to optimize user experience.
In Canada, the regulation of financial services as a whole falls under the shared jurisdiction of the federal and provincial governments. Regulators oversee aspects of financial services such as investor protection and securities law, consumer protection, anti-money laundering, privacy and data security, and payment processing.
In the U.S., the federal government oversees the financial services industry, with occasional involvement from state and local officials to help regulate markets and certain companies.
The International Data Corporation (IDC) releases an annual ranking of all fintech companies based on calendar year revenues.
The categories are divided into ‘FinTech Rankings: Top 100’ for vendors that derive more than one-third of their revenue from financial institutions, and ‘FinTech Rankings: Enterprise 25’ for companies that derive less than one-third of their revenues from financial institutions, and serve multiple industries.
The Fintech 100 is a showcase of the world’s leading 50 ‘Established’ fintech companies, and 50 ‘Emerging Stars’ that is released by KPMG and H2 Ventures on an annual basis.
Fintech was pioneered by people from the banking industry who were tired of the old way of doing things and business owners themselves, who are committed to providing a better, more transparent experience for users.
This is already having a ripple effect within traditional financial services. Many fintech companies and banks have started to form partnerships to help improve upon the current business model. As long as these partnerships continue to put customers’ needs first, the outlook is promising.
Alternative funding refers to all the non-bank options that are available for small businesses, such as non-bank lending (including online lending), crowdfunding, grants, angel investors, venture capitalists, and factoring or invoice advances.
A non-bank financial institution (NBFI) is not considered a full-scale bank because it doesn’t engage in both lending and accepting deposits – they do either one or the other. For example, a retail store offering a credit card is a non-bank institution since it does not accept deposits.
Non-bank lenders provide alternative loans. Some traditional forms of non-bank lending for small businesses include merchant cash advances, accounts receivable financing, and invoice factoring – these provide funding based on accounting data such as future sales and pending invoices.
Some traditional forms of non-bank lending for personal loans are retail credit cards and payday loans.
Fintech lending, or online lending, refers to newer forms of non-bank lending that are made possible due to technological innovation. In particular, online lending has become a popular financing option for small businesses, as opposed to obtaining a loan from a bank.
This is because banks require a strong credit history, something that a small business with little to no historical records is unable to provide. Due to this and an increasingly conservative financial climate, banks have scaled back on the number of loans that are offered to small businesses, which has led to a sizeable credit gap.
Approximately 60% of small businesses require loans that are under $100,000, which is exactly the market gap that online lenders seek to fill (Forbes).
Put simply, lending companies provide loans to individuals or businesses. A lending company will provide a quick and simple way to access cash, often to help small businesses sustain their daily operations.
Lending companies typically have arrangements with investors to provide the ‘loaning money’ to their customers.
Similar to a loan at the bank, you need to apply for a loan with an online lender.
Unlike banks, which put a heavy emphasis on personal and business credit, online lenders have the ability to take other factors into consideration, such as cash flow, sales history, online reviews, and even social media interactions.
The biggest benefit of online lending is that the entire process is much easier than with a traditional bank. Below are some of the biggest benefits:
The European Central Bank defines a fintech bank to be one which has “a business model in which the production and delivery of banking products and services are based on technology-enabled innovation”.
In layman’s terms, the central role of technology is what separates a fintech bank from a traditional one.
Although fintech companies are putting pressure on traditional financial institutions, the reality is that fintech won’t kill banks. Fintech companies are growing fast, however they are still tiny in comparison to the banking industry. For example, the biggest fintech lender till date has arranged loans of up to $9 billion, however credit card debt in America alone is at $885 billion. Fintech companies are dealing in billions, whereas banks are dealing in trillions.
Plus, banks have some ingrained advantages such as access to customer chequing accounts, being able to create credit at a whim, and having nearly every household as their existing customer. While fintech companies won’t kill banks, they may reduce their profitability and force them to change to make their services more competitive.
Some traditional sources of finance that are available are:
However, the problem with many traditional sources of finance such as banks and investors are that they involve a lot of time, red tape, paperwork, and they place a very large emphasis on past credit history, which most startups and small businesses don’t have.
Fortunately, due to the rise of digital solutions at fintech companies, some online sources of finance that overcome these hurdles are:
It has also become easier to access certain traditional sources of finance online, namely:
Crowdfunding refers to raising money for a new project or venture from a large number of people, who each contribute a relatively small amount. This is typically done via the Internet or a crowdfunding site, also known as a crowdfunding platform.
Modern day crowdfunding first began in 1997, when a British rock band raised money for its upcoming reunion tour from fans via online donations. This innovative idea gave birth to the first crowdfunding platform, called ArtistShare. Since then, the crowdfunding industry has been growing consistently each year, gaining significant traction in 2008.
There are four different types of crowdfunding available; these differ based on what is received in exchange for a contribution:
Crowdfunding takes place on a crowdfunding site, also known as a crowdfunding platform. Whether you are looking to raise or contribute funds, you will need to register with the website in order to participate.
Crowdfunding sites will typically list all projects or ventures that are being pitched on the website. Each project or venture should provide details such as:
Crowdfunding money goes to the project owner or venture only if it raises the full amount of the contribution goal stated in the pitch.
Crowdfunding is used for a variety of reasons, from raising money for a sick family member to launching a small business. Below are some common users that benefit from crowdfunding:
Crowdfunding is appropriate for all the users mentioned above.
It is also an option for small businesses that are unable to secure a bank loan or bring on an investor. Businesses encompassing the following factors generally have the most success with crowdfunding projects:
It is important to note that crowdfunding is most popular for personal financing, but it may not be the best solution for business financing, especially as an ongoing solution.
Whether you’re an individual or a small business, crowdfunding can be an effective way to raise funds. Here are five reasons why it works well:
There are five main reasons why crowdfunding may not be a good idea for some small businesses and startups:
Similar to fintech as a whole, crowdfunding is important because it helps out underserved markets that are unaddressed in the traditional financial ecosystem. Crowdfunding has made access to capital easier, faster – and in some cases, even possible at all.
For small businesses, crowdfunding helps bypass the red tape that blocks access to capital. According to a Global Entrepreneurship Monitor study, 95% of business plans received by venture capitalists and accredited investors have been rejected. Oftentimes, this is because a startup does not have enough years in business, a strong credit history, or proof of market demand.
Crowdfunding is also important because it helps individuals and organizations with a social cause. For example, a family member who otherwise would not be able to afford medical care for their loved one, or a local charity that can now expand its fundraising efforts to a global scale and raise more funds.
Yes, absolutely anyone can use crowdfunding. All you have to do is set up an account on a crowdfunding website, build a campaign, and post it. Some platforms will have certain requirements or an application process, which also need to be considered.
While crowdfunding can technically be used to start a business, it may not be the best option for first-time small business owners. This is because raising funds can take a long time, and the success largely hinges on having a large social media presence or existing community.
Yes, any nonprofit can take advantage of the benefits of crowdfunding. Just like any other fundraising activity, it is important that nonprofits review the laws that regulate fundraising in their region. For example, many states in the U.S. require nonprofits to register with the state before raising funds.
Yes, crowdfunding is an excellent way to raise funds for charities. Crowdfunding must be treated like any other fundraising activity and charitable registration is required.
There are many measures put in place by regulatory bodies and crowdfunding portals to ensure that the experience is safe. Below are some of the safety measures that are taken to protect users:
If you are investing in a crowdfunding venture or project, keep in mind that some level of risk will exist, as with most other investments. A good rule of thumb is to start small and diversify your investments across multiple sites.
From the four different types of crowdfunding listed above, two of these are regulated and two are unregulated. Donation-based and reward-based crowdfunding are not regulated, since the amounts are typically small and contributors are not receiving money in exchange.
Investment-based (equity crowdfunding) and loan-based (peer to peer lending) however, are regulated since they involve much larger amounts, and contributors receive money in exchange as well.
Canada regulates securities at a provincial level; each province and territory has its own securities commission and legislation e.g. the Ontario Securities Commission.
Within the U.S., crowdfunding is subject to oversight by the Federal Trade Commission (FTC). In order to operate, a crowdfunding platform has to register at a federal level with the Securities and Exchange Commission (SEC) and become a member of the Financial Industry Regulatory Authority (FINRA).
In addition to federal and provincial regulations, crowdfunding portals have their own standards that often exceed those required by regulators. Funding portals go the extra mile because they realize that in order to be successful, they have to offer the best protection for their users.
This question most often refers to equity crowdfunding, which is surrounded by a lot of misinformation and confusion.
In Canada, equity crowdfunding is legal under the Accredited Investor and Offering Memorandum exemptions. These are two exemptions that securities regulators provide to allow Canadians to raise funds from crowdfunding.
In the United States, equity crowdfunding is legal under Title III of the Jumpstart Our Business Startups Act (JOBS) as of May 16, 2016.
As of August 2017, all states permit some type of intrastate equity crowdfunding aside from a few exceptions.
The following states are in various stages of enacting or considering intrastate equity crowdfunding:
The following state has rejected intrastate equity crowdfunding:
The following states/territories have neither enacted nor rejected intrastate equity crowdfunding exemptions:
There are two main classes of investors for equity crowdfunding: ordinary citizens and accredited investors. Canada and the United States allow both classes to participate in equity crowdfunding within certain parameters. Some other countries only allow accredited investors to participate, or are bringing rules into motion that will allow ordinary citizens to invest.
Accredited or eligible investors are essentially high net worth individuals that meet certain income or asset holdings and are deemed to be more sophisticated investors by regulatory bodies.
In 2012 there were less than 500 crowdfunding platforms. Just two years later in 2014, there were over 1000 platforms and this number is continuing to rise.
What’s more, there are certain innovations taking place in the fintech space that will continue to encourage this growth:
Crowdfunding contributions are tax deductible under a donations-based model if the recipient of funds is a qualified charity. If you are donating to a business or other project, your contributions are considered personal gifts instead of tax-exempt donations.
The tax implications on crowdfunding funds will differ based on the crowdfunding model that is being used, as this will determine how the funds are labeled i.e. business income, gift, loan or capital contribution.
While there is no definitive guide on the matter – both the CRA and IRS do not have an official stance as yet on all aspects of crowdfunding – below are some basic guidelines.
Peer to peer lending means that borrowers can take loans from individual investors who are willing to lend their own money at an agreed interest rate. A peer to peer lending service essentially cuts out the middleman, such as a traditional financial institution.
Technically, peer to peer lending is a form of debt-based crowdfunding since a borrower can raise funds directly from multiple investors.
A peer to peer lending platform is a for-profit organization that connects borrowers with lenders, in order to facilitate peer to peer loans.
Peer to peer lending platforms request borrowers to fill out an application, who then assess credit risk, determine a credit rating, and apply an interest rate to their profile. Individual investors view the profile of a borrower and assess whether they want to risk lending money to them.
Borrowers can then receive the total loan amount from an individual investor, or multiple investors. In the case of the latter, monthly repayment has to be made to each of the individual investors. Borrowers tend to receive a lower interest rate than they would have gotten at the bank. All monthly repayments are made through the peer to peer platform.
Lenders generate income from the interest on the loan amount they provide to the borrower. The interest amount often exceeds what they would have received using a traditional vehicle such as a savings account at a bank.
If you are a lender, there will be a minimum amount you need to invest based on the lending platform you are using. The minimum amount is $25 for popular lending platforms in the United States. Companies will typically charge a percentage annual fee to investors.
In the United States, you need to make sure you live in an approved state and have a minimum gross annual income of $70,000.
As a borrower, you will need to fill out an online loan application found on the peer to peer lending platform.
Peer to peer lending took off in the mid-2000s when borrowers were getting frustrated with the banking sector’s dominance over the loan process. In 2015, Zopa was the first company in the world to offer peer to peer lending. The next most significant peer to peer lending company that launched was Funding Circle in 2010.
Peer to peer lending is one of the fastest growing segments in the financial services industry, with hundreds of sites across the world. As of 2017, the volume of global payments and remittances was over $1 trillion yearly, with per annum growth rates in peer to peer lending volumes reaching 50%.
As one of the fastest growing markets, the United States is predicted to hit 45% of the global market share in 2020 and generated $6.6 billion in loans in 2015.
Peer to peer lending can be safe or unsafe, depending on your lending strategy. If you lend to high risk borrowers, there is a higher risk of default. However, if you lend to lower risk borrowers with a strong credit rating, peer to peer lending will be safer.
Peer to peer lending is also more secure when you take a conservative approach and diversify your investments, instead of lending all your money to one borrower.
Peer to peer lending in Canada is regulated, however it is a process that is still evolving. Canadian securities regulators have taken the position that peer to peer loans could be ‘securities’, and therefore peer to peer lending platforms need to register as securities dealers at a provincial level. In some cases, Canadian peer to peer lending platforms need to file a prospectus if they are issuing securities.
To sidestep this requirement, many peer to peer lending companies are using existing exemptions such as restricting investment to accredited investors.
Within the United States, the lending side is regulated by the Securities and Exchange Commission. The borrowing side of the business is regulated by other agencies such as the Consumer Financial Protection Bureau and the Federal Trade Commission.
Yes, peer to peer lending is legal in both Canada and the United States. However, the regulations involved for companies to be legal are still quite complex and evolving.
Every state in the United States has their own set of lending rules and regulations and laws about investments in securities. Some states can borrow and not invest, some can invest but not borrow. And some can do both.
Lastly, it also depends on which peer to peer lending platform is being used, as some states are open to one, but not the other.
Depending on the platform, borrowers may face restrictions in:
Peer to peer investing is legal in all states aside from Ohio.
Interest earned from peer to peer lending is taxed, similar to other investment income. As an individual, interest income will be taxed at a marginal rate. Losses on loan defaults are also able to be deducted.
A business line of credit is an arrangement between a borrower and lender – typically a bank, but fintech companies are now an option – that allows for a maximum loan balance that the borrower can maintain and is subject to an interest rate. A borrower can draw funds from the line of credit at any time, as long as the maximum loan amount is not exceeded.
You can pay back any amount, so long as you make the minimum monthly payments that are set by the lender. These monthly payments can be a combination of interest and principal, or only interest.
Yes, you can apply for a business line of credit online through a lending institution’s website, by submitting an online application.
This is a lump-sum payment that is provided to a small business by a merchant account provider in exchange for a percentage of future credit card sales i.e. repayment is directly tied to future sales.
Merchant cash advance payments are automated and typically withheld by the credit card processor until the initial amount plus interest is paid back in full.
Yes, merchant cash advances are legal. Merchant cash advances are technically not loans, since they are a portion of future credit or debit card sales. Therefore, they are not bound by usury laws and can charge higher interest rates.
Although payments made towards the principal are not tax deductible, you can deduct the cost of interest on the loans. Overall, merchant cash advance loans will not protect your income from taxes and will also not subject you to additional taxes, so they are by and large tax neutral.
Cash advance online – also known as a payday loan – is a convenient way to get quick access to funds, but it can come with very high interest rates. Although the industry is regulated, borrowers need to take extra care in seeking out reputable lenders.
A much safer option is invoice factoring; this also provides quick access to a lump-sum amount, but at a much lower fee. For example, FundThrough is able to provide 100% of the invoice value upfront to customers with rates as low as 0.5%.
Invoice factoring is the process by which a business sells its invoices to a third party (called a factor) at a discount. This helps businesses with slow-paying customers meet their immediate cash flow needs and cover business expenses.
Invoice factoring is also known as accounts receivable factoring and accounts receivable financing.
An invoice factoring company will typically purchase an invoice in two installments. The first installment will cover approximately 80% of the receivable, and the second installment will cover the remaining 20%, less the factoring fee, once the client pays the invoice in full.
If you are a small business, these are the steps you would follow:
A factoring company will charge a factoring rate – or factoring fee – for their service, which is a percentage of the total amount of invoices being factored.
The factoring fee varies per business, and will depend on:
A typical factoring fee for 30 days will generally range from 1.5% to 4.5% per 30 days.
There is a difference between the total factoring cost and the factoring rate. To calculate your total factoring cost, you have to consider the two components: the factoring advance, and the factoring rate.
The advance is the percentage of the invoice that you get up front and is equivalent to the sum total of your first installment e.g. 80% of the total invoice. The factoring rate is the cost of financing, based on the value of the invoice.
For example, an 80% advance at a rate of 3.5% will have a total cost per dollar of 4.4 cents (0.035/0.80*100).
Invoice factoring is an excellent choice for small business owners that are looking for fast, ongoing access to cash at a lower rate than most other options.
These are the biggest benefits of using invoice factoring:
The difference between invoice discounting and factoring lies in who takes responsibility for collecting payment from debtors. With invoice factoring, the factoring company takes responsibility for collecting payments, whereas with invoice discounting, the business still retains control of collecting payments.
Invoice discounting also allows for more confidentiality; customers do not need to know a third-party factoring company is involved in assisting the business with its cash flow. With invoice factoring however, customers are making payments directly to the factoring company.
However, this is not the case with all invoice factoring companies. For example, FundThrough makes it possible for the payee to remain confidential.
Invoice factoring companies are not regulated by a formal government body, which allows them to serve small business owners that are unable to secure a bank loan.
Most invoice factoring companies are self-regulated and are members of associations such as The International Factoring Association and the Commercial Finance Association in order to ensure they are following best practices.
Online lending is safe if you work with a reputable and reliable lending company or platform. As with any other life or business decision, finding a safe online lender requires some due diligence.
Before applying for a loan, use the Internet to do some quick research about the potential lending company or platform. You’ll want to look for the following:
You will need to create an account with the lending platform or company, and fill out an online application. Fortunately, applying for funds online has become very quick and simple.
For example, with FundThrough you can create your account online in two minutes and receive invoice factoring approval within 24 hours.
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