Peer-to-peer lending and crowdfunding provides you with two ways to invest in the next big player in the market at a key stage of their development, plus make yourself a healthy return at the same time. By Sean Blanks, marketing director of cartridgesave.co.uk.
Obviously there are risks involved in P2P lending, so below we've mapped the options available and the things to keep in mind to maximise profit.
Firstly, there are two key ways to invest in other people's companies - either by buying a stake, or by lending money. The latter is known as peer-to-peer lending (P2P). In the UK, it is becoming pretty big business. In the last year alone, the amount lent has doubled to more than £2.4bn, according to the Liberum AltFi Volume Index UK.
How peer-to-peer lending works
The easiest route is through P2P platforms, which provide investors with a marketplace to meet businesses in need of investment. Acting like banks investors, they pledge financial support and the recipients agree to repay the loan with interest. By cutting traditional banks out of the equation, P2P platforms enable both the investor and the business to get a better deal, and the platform simply takes an arrangement fee.
One of the biggest P2P platforms in the UK is Funding Circle. Since launch, it has helped fund £1bn worth of business loans. Part of Funding Circle's allure is the return they estimate. Their marketing materials predict investors can make a return of just over seven per cent before tax, and after you’ve paid their one per cent fee. They also offer an auto bid facility so you can split your finance over a number of businesses without getting bogged down in the detail.
One of the main risks in lending, however, is the business you've invested in going bust, which means your loan will not be repaid. The best way to minimise this is by spreading risk. I would suggest that you look to invest in 100 businesses, putting no more than one per cent of your capital in each, which means if you're driven by the romance of being an angel, this is not the model for you. However, if you're looking for a sensible investment model, P2P is definitely worth considering.
P2P platforms to consider
Funding Circle has a minimum loan of £20, which means you're looking at investing £2,000 to spread credit risk. An alternative to Funding Circle isThinCats, which has a minimum loan size of £1,000. Multiply that by a hundred and you're looking at making a pretty significant investment!
Another way to invest in the sector is through a P2P investment trust. This is a company listed on the stock exchange, like P2P Global Investment, that invests in a range of start-ups across the UK, US and Europe.
Crowdfunding is higher risk than P2P. This option allows you to buy stakes in fledging start-ups that advertise through a dedicated crowdfunding platform.
This sector is much smaller in comparison to P2P but thanks to recent well-publicised success stories like Pip and Nut that raised £120,000 on to create one of the fastest growing grocery brands, it’s growing quickly. Places to look include Seedrs and Crowdcube. Here you can invest from as little at £10, which means you can create a nice portfolio without it costing the Earth.
Investing in start-ups is very risky as the failure ratio is high. Even the most experienced angels regularly have to write-off investments. However, find the next Facebook and you can make yourself a fortune.
Plus, the associated risk appears to be decreasing thanks to a stable economy. Beauhurst reports that the risk levels associated with crowdfunding have dramatically reduced in recent years with the failure rate falling from 25.4 per cent in 2013 to 0.5 per cent in 2015. In fact, the failure rate of crowdfunded companies is currently below that of non-crowd funded companies (0.9 per cent).
However, as with P2P lending, I would really recommend that you spread your investments. Don't ever be tempted to put all your eggs in one basket.
Other risks to consider with crowdfunding
- Little communication. The great thing about investing in a company that's floated is that you get regular updates on exactly what your investment is worth. With a start-up, you have no way to know for sure how much your investment might eventually give you, what's going on behind closed doors and if the company is going to work out.
- No timescales. Similarly, you will not be given a realistic timescale for eventual buy-out.
- Dilution. This is the worst risk in my book. It means that your start-up might have to raise more capital at a later date meaning the stake you hold gets diluted.
The benefits of crowdfunding
From a personal point of view, crowdfunding offers more satisfaction as it allows you to contribute to the growth of companies at the very early stages. It doesn't need to cost a lot but with it you get the buzz of helping entrepreneurs like you get an idea off the ground without any of the hard work!