Different Types of Alternative Sources of Finance
The different types of alternative sources of finance are listed as below:
- Leasing
- Franchising
- Forfeiting
- Peer-to-peer Platform
- Crowdfunding
- Angel Investors
- Venture Capitalists
Leasing
- A lease is defined as an agreement between the lessor (owner of the asset) and the lessee (user of the asset), wherein, the lessor purchases an asset for the lessee and allows him to use it in exchange of periodic payments called lease rentals or minimum lease payments (MLP).
- The lessee is bound to pay the lease rental to the lessor for the use of the assets. After the end of the period of the contract, the asset is transferred back to the lessor.
- It refers to the renting of an asset for a certain period of time.
- Parties involved include lease broker, lessor, lessee, and the lease assets.
| Advantages | Disadvantages |
| Lessee acquires the asset with a lower investment | May impose certain restrictions on the use of the assets |
| Simple documentation process | Normal business may be impacted in the case of non-renewal of lease |
| Does not dilute the capital structure | Higher payout obligation in case equipment not found |
| Risk of obsolescence is born by the lesser | Lessee cannot become the owner of the asset |
| Lease rentals are deductible for computing taxable profits | Regular maintenance of the asset |
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Franchising
- Franchising is the model in which the Company that does not have enough capital to expand, gives its franchise rights to an individual or a company.
- The company giving rights is called ‘franchisor’ while the company being given the franchise is called ‘franchisee’.
- It is an arrangement where one party grants or licenses some rights and authorities to another party.
- Franchising is a well-known marketing strategy to expand the business.
| Advantages | Disadvantages |
| Helps in expanding business | Franchisor own goodwill may suffer in case of failure by the franchisee |
| Builds a brand name and goodwill | Lack of secrecy |
| Less efforts by franchisee for startup | Lack of autonomy to the franchisee |
| Zero cost involved for training and assistance as it is provided by the franchisor | Sharing of royalty and profits with the franchisor |
Types of Franchise:
- Product franchise: An agreement where manufacturers allow retailers to distribute their products and use names and trademarks.
- Business format franchise: An agreement in which the franchisor provides the franchisee with an established business, including name and trademarks for the franchisee to run independently.
- Management franchise: The franchisee provides the management expertise, format and/ or procedure for conducting the business.
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Forfeiting
- It is a form of financing of receivables arising out of international business. Wherein, a bank or financial institution undertakes the purchase of trade bills or promissory notes without recourse to the seller.
- Purchases are made through discounting of the documents, hence covering the entire risk of payment failure at the time of collection.
- All risks become the full responsibility of the purchase
- Forfeiture pays cash to the seller after the discounting of the said notes or bills.
| Advantages | Disadvantages |
| Immediate funds available for the exporters | It is not available for deferred payments |
| Commercial bank can gain when the currency values appreciate | Only selected currencies are considered for forfeiting |
| Letter of credit provides great help | No international credit agency to guarantee in case of default |
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Peer-to-peer (P2P) Lending
- Peer-to-peer lending is a form of direct lending of money to businesses or individuals without any official participation of any financial institution as an intermediary in the agreement
- It is generally done through online platforms that relate lenders with potential borrowers
- Peer-to-peer lending offers both secured and unsecured loans. However, most of the loans are unsecured personal loans. Secured loans are an exception and are usually backed by luxury goods.
| Advantages | Disadvantages |
| High returns to the investors as there are no middlemen involved | Credit risk because of low credit rating buyers |
| More accessible sources of funding because of less complexity | Government do no provide any insurance or protection on such types of loan. It is not allowed in many countries |
Services provided by P2P Platforms:
- Finding new lenders and borrowers
- Verification of borrower identity, bank account, income, and employment history
- Legal compliance and reporting
- Performing borrower credit checks and sorting out the unqualified ones
- Servicing loans, providing customer service to borrowers, and attempting to collect payments from borrowers who are in default
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Crowdfunding
- It is the practice of funding a project by raising money from a large group of people.
- It is a way of raising capital using the social networking sites like Facebook or Twitter or by using some popular crowdfunding websites
- Crowdfunding helps improve the presence of small businesses and startups across social media, it increases their investment base, and funding prospects.
- Various types of crowdfunding include debt-based, equity-based, cause-based, rewards-based, software value token, litigation, etc.
| Advantages | Disadvantages |
| Quick way to raise finance | Public may not show interest in all the projects |
| Feedback and expert guidance accompanies funding | Significant resources needed for marketing about projects |
| Great way to test public reaction | It may not result in comprehensive financing |
| Easy to track progress | Reputation of a business can be severely affected |
| Cheap source of finance | Lack of project secrecy |
Venture Capital
- It refers to that capital and knowledge which are given for the formation and setting up of companies, especially to those who possess any new methodologies or technology.
- It is not merely a way of acquiring funds into a new firm but also a parallel support of the skills required to set up the firm, devising its marketing strategy, organizing, and its management as well.
Stages of Crowdfunding
- Seedling finance for the development of the business idea
- Start-up finance for starting up the new business enterprise
- Fledgling finance for the supply of funds as the company operates if it is not able to generate funds on its own
- Establishment finance to scale-up the business
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| Advantages | Disadvantages |
| Feeds wealth and expertise into the business | Autonomy and control is shared with venture capitalists |
| No obligation to repay the money | Process is lengthy and complex |
| A large sum of equity finance is available | Uncertain forms of financing |
| It provides valuable information, resources, and technical assistance | Benefits are available only in the long-run |
Angel Investors
- They are an individual or a group of individuals who invest their own money
- They invest in the early stages of the company and in return opt for a share in the company
- Angel investors typically invest less money that the venture capitalists
- They are not involved much in the functions and management of the company. However, they may advise and ask for reports and status.
| Advantages | Disadvantages |
| No need for collateral like personal assets | Not suitable for investments below INR 5 lakhs or above INR 15 lakhs |
| No repayments or interest on borrowings | It takes longer to find a suitable angel investor |
| Better discipline due to outside vigilance | Less structural support available |
You might also be interested in: Changing Landscape of the Banking Sector in India The above finance study notes on Alternative Sources of Finances covering all the possible sources in the finance world. For more such interesting and helpful exam-preparatory material, do get hold of our Testbook App today! It is a very useful app to get ready for all kinds of competitive examinations without any worries. Just download the app and get started with your preparations right away!
