Finance is a world awash with jargon. For anyone but the experts the torrent of technical terminology can be bewildering. However, hidden behind many of the terms and phrases is usually a simple idea, and often a familiar one at that. In this Altimapa guide we define the most commonly used terms that you may encounter when dealing in the world of alternative finance.
Alternative finance
An all-encompassing term to describe the proliferation of channels, companies and instruments that have emerged outside the realm of the traditional financial system. The term is most commonly associated with companies operating in the peer-to-peer space, such as peer-to-peer lending and crowdfunding. Often called “shadow banking” as well.
Amortising loan
A type of loan where a part or all of the principle is repaid alongside interest during the lifetime of the loan.
Asset-backed loan
Debt where the security of the loan is specifically tied to an underlying asset. The range of assets that may be used as security can be wide, including property, inventory and trade receivables.
Bullet loan
A type of loan where the entire principal of the loan is repaid at its maturity.
Capital structure
A term to describe the composition, and relative rank, of the instruments used to finance a company. The capital structure incorporates debt, hybrid instruments (such a mezzanine debt and preferred equity) and equity.
Direct lending
Direct lending is the provision of debt capital to small and and midium sized businesses (SMEs and MMEs) by private debt funds. Loan sizes tend to be significantly larger than those available in peer-to-peer lending, typically ranging between £2 and £100 million.
Factoring
A loan like transaction, where a company sells its trade receivables to a third party. The sale of the receivables usually occurs at a discount, with the difference between sale price and notional value providing an effective interest to the purchaser.
Growth capital
A type of hybrid-capital used to provide non-dilutive finance to rapidly growing firms. Typical growth capital investments will include a debt instrument, as well an equity component in the form of a minority stake, preferred equity or warrant.
Invoice discounting
A similar source of finance to factoring, invoice discounting maintains the relationship between buyer and seller, with the collection of the cash remaining the responsibility of the company.
Junior debt
Debt that ranks below senior bonds or loans but above common equity. Junior debt instruments are often called mezzanine loans but can also be structured as preferred equity.
Loan-to-value (LTV)
A measure of the value of a loan relative to the collateral that it is secured against. A €30 million loan secured by a €50 million property would be described as a 60% LTV loan.
Mid-Market
A term typically described as those business with revenues of between €50mn and €1bn, however precise definitions can vary wildly with different geographies and industries often having their own convention.
Mezzanine
A subordinated loan that sits beneath (or is ‘junior to’) senior loans in the capital structure. Mezzanine loans carry a considerably higher interest rate to compensate for the higher risk.
Payment-in-kind (PIK)
A form of interest payment where, instead of the interest being paid in cash, its value is rolled up into the principle of the loan. PIK loans are often used as a way of reducing the cash flow burden of the debt on the borrower.
Peer-to-peer lending
A form of debt finance, where individuals lend money to other individuals or businesses intermediated by an online platform. Funds are lent to small and micro businesses usually in sizes of between £10,000 to £500,000 – with the average loan size around £60,000.
Private debt fund
A type of closed ended fund with the investment mandate of making loans to commercial entities.
Private placement
A form of bond issuance traditionally used by large cap companies, where debt is negotiated directly with a small group of investors. Private placements are becoming increasingly used to finance SME and Mid-Market firms and are being heavily supported by the ECB as part of the Capital Markets Union.
Senior loan
A loan that ranks above other debt and equity, and therefore the lender has first recourse to all assets in the case of a bankruptcy. For an investor, senior loans are the safest type of long-term financing and therefore usually carry the lowest interest rate.
SME
SME (Small and Medium-sized Enterprise) is a catch all term for all businesses that fall below a certain size. The European Union classifies SMEs into [3 groups] (http://ec.europa.eu/growth/smes/business-friendly-environment/sme-definition/index_en.htm): micro (with less than 10 employees or €2mn in turnover), small (with less than 50 employees or €10mn in turnover) and medium (with less than 250 employees or €50mn in turnover). The UK government classifies SMEs as businesses that meet two out of the following three criteria: less than £25mn in turnover, less than 250 employees and less than £12.5mn in gross assets.
Supply Chain Finance
The provision of finance to the buyer of goods, often employed to smooth payments for suppliers. Also known as reverse-factring.
Term loan
Term loans carry a predetermined interest rate, maturity date and repayment schedule (typically monthly or quarterly). Term loans typically last between 1 and 10 years and are often borrowed with the intention of purchasing an asset that will generate the cash flow to service and repay the loan.
Unitranche loan
A single debt instrument that incorporates both a senior loan and a mezzanine loan. Unitranche loans allow companies to increase the leverage in their capital structure, without needing to deal with multiple lenders.
Venture debt
A form of debt where a fund invests money in a high-growth company in order to accelerate growth or pay for an acquisition. Unlike traditional borrowers, companies that borrow venture debt are not required to be profitable or have significant assets to secure investment.
Warrant
An option that gives the owner the right to purchase shares in a company at a set price. Warrants are often used to cheapen to cost of debt for a borrower.