What startups need to know about the future of finance
Starting a business is a challenging undertaking but even more so in today's economic climate. However, with adversity comes innovation. For founders and entrepreneurs, engaging with technology that is disrupting the rigidity of the finance sector can be the path to success.
From alternative finance and AI, to embedded finance, entrepreneurs now have a vast array of alternatives and emerging technologies to look at when accessing funding.
The current landscape
It’s no surprise that high street banks have been tightening their belts, making it harder for entrepreneurs to access funding through traditional routes. Additionally, the economic downturn saw venture capital (VC) funding for startups plummet by more than 50% in the last year. VCs are nervous, and for good reason.
In March, we saw Silicon Valley Bank being closed by financial regulators. In the aftermath, VCs were spooked, introducing stricter terms for lending that forced startups to delay, or forgo, their growth plans. The startup sector felt the impact of lenders becoming risk-averse, and founders had to look elsewhere for capital.
There are, of course, government grants and industry-wide funding programmes, but these can have strict application criteria and deadlines, British entrepreneurs are certainly complaining of a lack of support and opportunities. Some are even limiting their applications to certain times of year, which can be difficult for entrepreneurs who need the flexibility and freedom to apply for funding when needed.
However, fintech startups continue to appear and innovate, perhaps because they are honing in on the possibilities offered by alternative finance methods. The future is moving towards frictionless financing, and traditional providers are taking notice of its speedy deployment and seamless, user-friendly experience. It’s good news for startups, with research finding that 75% of banks will be looking to engage with fintech innovators in the next 12-18 months, resulting in a growing number of funding solutions. Here are a few of the models being adopted:
- Peer-to-peer or P2P lending is a form of alternative finance that allows individuals to lend money to other businesses through an online platform. For startups who may struggle with securing funding through traditional routes, this can be an attractive option. The benefits can include lower interest rates and more flexible lending criteria.
- Invoice financing allows startups to leverage pending invoices, so they can access funds in exchange for a small fee. Expenses can be covered immediately, from paying employees to investing in the next steps towards growth.
- Revenue-based financing allows startups to borrow funding against their expected, future revenue. Instead of paying back a set amount per month, startups repay their loan in line with their monthly revenue, with a percentage calculated based on this. There’s also no need for startup owners to sacrifice the equity of their business.
- A line of credit gives borrowers the ability to withdraw funds as needed, up to a predetermined credit limit, with interest only being charged on the amount of funds withdrawn.
- Term loans are a fixed-amount loan provided by a lender to a borrower, to be repaid with interest over a set term, or period of time, which is ideal for startups who have a predictable cash flow as they follow a clear timeline for repayment.
How finance is harnessing the power of AI
Artificial intelligence (AI) is revolutionising many industries, and finance is no exception. Financial service providers can leverage AI to offer personalised solutions to their customers, as well as automate elements of the risk assessment. A Forbes article stated: “AI has already helped 36 percent of financial services execs [interviewed] reduce costs by 10% or more.”
Able to analyse swathes of data, AI can help lenders more accurately determine the risk of borrowers, reducing human-error and the time involved in assessing lending applications. Using machine-learning algorithms to assess risk, AI can determine the best lending options for startups based on their financial profile and direct them to the most suitable funding solutions. This means that startups can access much-needed capital at the point of need, and with greater accuracy, all whilst reducing the risk of default.
Embedded finance as a lifeline for startups
Embedded finance refers to traditional financial services such as payments, banking, insurance or lending, that are provided directly to startups by non-traditional players. There are embedded payment services, such as WorldPay, that allow startups to accept payments directly within their existing financial ecosystem. Entrepreneurs can use the integrated banking services in their current platform, without needing to switch between different platforms and allowing for a smoother user experience.
Embedded lending services allow startups to access new sources of funding that may not be available through traditional channels, such as revenue-based financing. Embedded lending providers are able to offer their services through acquirers such as Barclaycard. Within these ecosystems, startups are able to request funding, and if eligible, will receive a pre-approved offer.
By increasing access to funding opportunities, promising startups have the ability to grow. For those who may be operating in an uncertain economic climate, embedded lending can serve as a lifeline.
Fintech is changing the world of finance, and startups have the chance to leverage the latest innovations in finance to overcome challenges. With alternative and embedded finance methods increasingly being powered by AI, there is a real opportunity for more and more startups to thrive.
The UK needs startups to continually invent and innovate in order to cement the country’s position as a leader in the startup sector and exemplar in the global economy. If founders can get the financing they need, they can innovate. This is why models that disrupt and enable will dictate the future of financing.