What will 2023 bring for alt-finance?

With headlines full of doom and gloom about the macroeconomic outlook in 2023, and global headwinds adding to domestic pressures, it is clear that businesses face a difficult period ahead. Europe’s SMEs, very much the bedrock of the European economy, are once again navigating challenging times, with increased pressure and more hurdles to jump over. That being said, European startups and SMEs are continuing to grow, and there is much reason to remain positive about the wider startup ecosystem. But access to finance remains critical, and with traditional lenders starting to pull the drawbridge up, the stakes are high and competition is strong for the money that is available. This is where alternative finance is able to step in, helping to plug the gap with speedy and accessible funding for businesses. Now valued at $6.62 billion and growing at a CAGR of 6.3% from 2022 to 2028, the alternative financing sector has a promising outlook and looks set to play an increasingly prominent role in supporting the business ecosystem in the future.

Comparisons can be deceptive

We are undoubtedly entering a global recession, but the shape, scale and length of it is hard to gauge. The tech industry is arguably at the forefront of this economic uncertainty, with many companies already starting layoffs and a noticeable drop in investment activity.  The mantra at the moment seems to be, ‘prepare for the worst’ based on the experience of previous downturns. However, when we look at the tech sector today, compared to the 2008 recession, there has been so much change that it would be misguided to turn to this example for what to expect and how to prepare. 

Fourteen years ago, Europe’s startups focused predominantly on consumer tech, or some small areas of fintech, mostly around cross border transfers and payments. Now, tech is an intrinsic part of every industry, and the sector is deeper and broader. Investment levels and valuations are unrecognisable. For context, in H1 of 2022, European tech companies raised €60 billion across 2,608 deals. In the entirety of 2007, funding hit a record of €7.5 billion: an amount it would not reach again until 2012. The startup community has grown from a niche network of professionals to one of Europe’s largest employers.  

New ways to weather the storm

Whilst some tech-enabled businesses are now struggling, those pure tech businesses, like SaaS, cybersecurity and martech, are continuing to grow, and need access to finance to support this growth and success. Another key difference, therefore, is that the startup scene is not solely reliant on VC capital to fuel growth these days. In 2008 the collapse in traditional sources of funding meant that new startups struggled, failures were exacerbated and growth severely curtailed. Crucially, viable startups were caught up in the storm, requiring them to make deep cuts which damaged their businesses and made recovery difficult - and in some cases - impossible. Not only did this prolong the recession it helped cause a domino effect which impacted much every tech vertical. 

Today, founders have the ability to access a large and rapidly growing alternative financing scene. There are scores of companies offering numerous ways for viable startups to continue to get capital and allow them to weather the storm. Traditional finance is also very different. Previously, getting a loan from a bank was essentially out of the question for many startups, now it’s a real option. Although many alt finance startups get their capital from VCs, most have built up huge war chests of credit over the past few years.

VC funding is going to continue to retreat in 2023 and valuations will also fall further. This means entrepreneurs will have to give up more equity to close significant VC-backed rounds. For early-stage businesses with good fundamentals this financing route will be particularly unattractive. As such, alt-finance and other forms of debt are going to play a much bigger role in the growth stories of many startups. We may see a new generation of startups that reach maturity in the next five years which have largely avoided taking cash from VCs. 

Different roles for different funding

The growth of alt-finance has also been driven by a realisation by many businesses that different sources of funding should be used for different purposes. We are increasingly seeing longer-term capital, such as equity and long-term debt, being used for bets and initiatives with uncertain returns, like new product development, research, and entering new markets. Whereas cost-effective non-dilutive capital is being deployed for more predictable purposes, like user activation and working capital.

There is also likely to be a large uptake in smaller, purpose-specific financing solutions. Businesses will take short-term debt to execute tactical plays to safeguard their business during the recession. This could be to shorten sales cycles, improve client conversions or sustain ongoing marketing and sales activity.  

I think that over the coming months we will see alternative financing in all its forms increasingly used by early stage companies as part of their capital stack in 2023 given the current macroeconomic climate. While we can be hopeful that Europe’s tech industry will start to climb out of its recession late next year, VC funding will take longer to reach the levels that we saw last year. When confidence does return, the tech funding landscape will have likely changed irreversibly, with a strengthened and expanded alt-finance sector, and a ecosystem of founders that fully recognise the benefits that it offers in supporting the growth of the next generation of startups.