Last month on GrowthBusiness’ sister website SmallBusiness, company owners and industry insiders shared tips on how growth businesses can negotiate a bank loan. The banks themselves admit that lending criteria are stricter than before and, even with the best preparation, tales of rejection still roll in from frustrated would-be fundraisers.

Such entrepreneurs can’t really be blamed for looking at alternative means of finance when seemingly viable business plans are shot down in flames. But aside from friends, family, founders and fools – the traditional four sources of funding for a growing business – there aren’t many other options out there.

Step forward social funding websites. In the past couple of years, this new breed of finance provider allows ‘armchair investors’ and savers to lend directly to businesses. The rationale is simple. The punters get equity or an attractive rate of interest. Businesses get their cash. Everyone wins – or that’s the theory.

The players

Funding Circle is the best established of the bunch, having lent in excess of £17 million to some 450 businesses. It was launched in 2010 broadly following the model of social lending sites such as Zopa, but set up to lend to businesses rather than individuals. Also of note is ThinCats, which has made 26 loans totalling £3.2 million, and the equity-based crowdfunding site Crowdcube, with some £2.4 million invested.

Mark Carton, co-founder of creative marketing consultancy Adessi, had been seeking £30,000 to develop a new range of gift wrap. The business was demonstrably profitable, but when he approached the high street banks for finance, they either weren’t prepared to provide support or offered unappealing rates. Carton saw an article about Funding Circle in a newspaper and decided to investigate.

Funding Circle suggested that Carton send in a business plan for scrutiny. ‘They weren’t trying to change our business plan to make the investment work for them; they understood that in some respects there were speculative elements to this. The only thing they were looking for were personal guarantees, which would have been the minimum if we’d have gone down the bank route.’

In the end, Carton secured a loan at an interest rate of 7.9 per cent, and the money was in his account within two weeks. ‘Our loan was 2 per cent cheaper than any rate offered to us by a bank. That’s quite a lot when you’re borrowing £30,000.’

Funding Circle’s upper limit for unsecured loans is £100,000, but there are other options out there for companies looking for more. Customark, a manufacturer of industrial labels, secured a £200,000 loan via ThinCats to fund a corporate acquisition.

Managing director Greg Lerigo says, ‘We wanted to buy [a pad-printing business] outright. Unfortunately, the banks aren’t keen to lend this kind of capital, preferring to fund much larger acquisitions.’

Banks wouldn’t have worked for Lerigo anyway. ‘During the recession I had a business that suffered heavily and had to go into administration,’ says Lerigo, ‘and my balance sheet at Customark didn’t look particularly strong at that time because I’d written off inter-company loans.

‘ThinCats looked beyond that. They are prepared to take healthy risks and, rather than focusing on where the business had been, they looked at the cash flow we are generating now through trading operations and took a view from there.’

Before they can be featured in an auction for a ThinCats loan, companies have to gain the support of one of ThinCats’ accredited sponsors, which help the company prepare an information pack on their business. The sponsors, claims ThinCats, have well-established track records in the banking and corporate finance industry and meet the company face-to-face several times in order to prepare the report.

Ready to boom

Does Lerigo think that the social lending sector is set to gain more visibility in the business funding landscape? ‘I think there is room for more players in this sector. Think about the growth of the payday loans market – they filled a niche there and these websites will fill the gap for businesses that want to invest in growth. It could be set to explode as a concept if the demand for funds can be matched by supply from investors.’

If businesses aren’t keen on a straightforward loan, they have the option to offer an equity stake through Crowdcube. The service works by publishing select finance pitches on its website. Users can invest as little as £10 in exchange for a fraction of the stake on offer.

Sue Acton, managing director of bodycare company Bubble & Balm, is among those who have raised money. Acton had heard about the US fundraising platform Kickstarter and found Crowdcube after looking for a UK equivalent.

The entrepreneur raised £75,000 and gave away just 15 per cent of her business. Not surprisingly for someone plumping for equity over debt, Acton had also been in talks with angel investors. ‘I had a couple of angels on board previously, but angels won’t be happy with accepting your valuation. That’s the benefit of Crowdcube – you’re doing things on your own terms, and overall this option seemed more equitable.’

One problem with Crowdcube is that there can be delays in raising money. Oliver Morgan, founder of Universal Fuels, looked for £200,000 through the website but noticed that investors were holding back for a specific reason. ‘As an investor, if you are first in with your money, it can be held without earning interest over a period of, say, four months,’ he says. ‘So it becomes a chicken-and-egg situation, where people want to be the last in with their money before the fundraising is completed.’

Morgan switched to raising the funds in tranches of £50,000 and, by the time you read this, expects to have completed the final round.

Too good to be true?

Talking to successful fundraisers can create an impression that this new movement can do no wrong – but the success stories come with a significant caveat. While Funding Circle says it is ‘difficult to ascertain exact rejection figures’ and ThinCats also doesn’t expose the numbers, Crowdcube reveals that it has received some 700 pitch requests but, of those, only 150 were published on the website. And of that 150, only 11 were fully funded by investors. Meanwhile, recent Sage research finds that four out of every five business loan applications were approved last year by banks.

Of course, this is comparing apples and oranges, but it does raise the important point that raising money through a social funding website won’t necessarily be any easier than getting a bank loan. In fact, the perceived ease of raising money through the web might be encouraging more applications and therefore lead to a higher failure rate.

Phil McCabe, senior policy adviser at the Forum of Private Business (FPB), says, ‘Perhaps some social funding platforms are victims of their own success. Certainly, there appears to have been a recent surge in interest, and there is a risk that some of these newer models are not yet fully equipped to deal with this.’

The FPB holds the view that, despite their new and innovative approach, the social lending platforms will struggle to compete in business finance markets that are traditionally dominated by the high street banks.

McCabe adds, ‘This is something that we warned the Office of Fair Trading about in 2010, and it is just as true now. While the newer entrants often have approaches to risk management that are more open for business than those of the big banks, they need better support [to compete] – particularly in marketing and sales.

‘Equity finance is another option, but entrepreneurs are frequently reluctant to sacrifice a stake in their business. In survey after survey they choose lending at interest – loans and overdrafts – as their preferred form of funding. And that is unlikely to change.’