You may have heard the term crowdfunding with increasing regularity since the recent financial crisis, largely due to the scarcity of affordable credit and the abundance of savers and investors seeking better returns than those being offered by traditional savings options.
Interest rates have been held at a record low for five years, which means innovative online investment platforms are an increasingly attractive investment vehicle. Both peer-to-peer lending and equity crowdfunding are proving extremely popular, but which one is best suited to your circumstances?
Online peer-to-peer lending platforms give you the opportunity to lend your money directly to individuals looking to take out a personal loan or to businesses seeking additional finance. In effect, you’re the bank, and by cutting out the large financial institution in the middle you receive the interest paid by the borrower and the borrower benefits from a low cost, flexible loan.
Borrowers need to satisfy a number of requirements before they are approved for a loan, and reputable peer-to-peer lending platforms operate a stringent approval process before lending your money.
As well as being subjected to rigorous affordability and credit checks, loan applicants are also checked against national anti-fraud databases, which further reduces the risk to your investment. Many peer-to-peer lending platforms also operate some form of reserve fund, which compensates lenders in the event of missed payments or defaults by borrowers. It is worth remembering that such stringent background checks and reserve funds are not usually offered by equity crowdfunding platforms.
Equity crowdfunding platforms allow you to invest directly in unlisted companies in return for shares in that company. Typically aimed at start-ups and relatively new business ventures, companies ‘pitch’ for the funds they need on dedicated, online platforms. Investors can then choose to invest in the new venture in exchange for a small percentage of the business.
Whilst this has the potential to deliver great returns over the long term, depending on the subsequent success of the company, it is also fraught with risk. The majority of new businesses fail within their first two years, so investing money into one at such an early stage is something of a gamble for the unsophisticated investor.
Making the right decision
If you want a level of certainty associated with your returns, the timescale of your commitment and the level of risk involved, the peer-to-peer lending option is undoubtedly the best for you. Of course, many are attracted by the possible returns from investing in businesses, but there is no guarantee you will receive your money back and you may not receive regular returns at all.
Once you have invested in an equity crowdfunding scheme, you can’t really plan the future of that investment with any accuracy. Peer-to-peer lending may not deliver the rare jackpot that a tiny minority of start-ups create, but it does offer a steady, low-risk investment opportunity that delivers returns way in excess of those currently being offered by mainstream banks. And while you may have to wait several years for any sort of return on your investment from an equity crowdfunding scheme, the repayments on a peer-to-peer loan will typically begin within a month of your initial outlay as borrowers start to make repayments.
Despite the differences between these two forms of crowdfunding, the choice for you as an investor is a simple one. If volatility and uncertainty of income are not an issue and you can afford to gamble on an unknown business entities, equity crowdfunding is an exciting opportunity. But if you want a steady income from the outset, and a range of protections designed to cover potential losses, peer-to-peer lending is definitely the way to go.
Nick Harding is founder and CEO at Lending Works. Lending Works is a peer-to-peer lender that matches thoroughly underwritten personal loan borrowers to shrewd lenders so both receive a much better deal. Lending Works is the first peer-to-peer lending company to have insurance that protects lenders against borrower defaults and fraud.