Peer-to-peer lending platforms enable investors to invest in debt instruments, whilst equity crowdfunding platforms enables investors to take an equity stake in a business or property.
Examples of peer-to-peer lending platforms
- Personal loans – Lending Works, RateSetter
- Business loans – Assetz Capital, Growth Street, Funding Circle
- Property loans – Kuflink, Landbay, TheHouseCrowd
Examples of equity crowdfunding platforms
- Unlisted businesses (typically start-ups) – Seedrs, CrowdCube
- Property – Property Partner
Are debt investments less risky than equity investments?
When evaluating debt/equity investments in the same company, debt is undisputedly a less risky investment as whilst the company would have no legal obligation to pay dividends to shareholders, it would be legally obligated to make repayments to its debt holders in line with contractual terms.
The question becomes more complex when evaluating a debt investment in one company vs. an equity investment in another. For instance, an equity investment opportunity in a business that features strong cash flow conversion and good growth prospects may be more attractive than a debt investment in a company whose profitability is relatively stable but reliant on a relatively small number of contracts.
Ignoring the differences between individual investment opportunities, we consider the key risk factors to consider with each investment type below:
Peer-to-peer debt investments
- Risk of default – If borrowers fail to make loan repayments in line with contractual terms, the loan is considered to be in ‘default’. This can arise as a result of a poor initial credit decision made by the platform or as a result of economic factors outside of the platforms control (e.g. unemployment, loss of a business contract). This reinforces the importance of diversification – the more you can diversify your P2P investments, the lower the risk associated with potential default. In the case of secured lending, the secured asset can be seized by the lender and sold. This may cover the capital losses associated with default, but cannot be guaranteed (e.g. the property market may stagnate resulting in property being sold at below expected value).
- Platform insolvency – In the case of platform insolvency, loan contracts remain in place between borrowers and lenders. However, it is likely that early access to funds via a secondary market would be difficult (if not impossible) with investors then needing to wait until loans are repaid to gain access to capital. The FCA rules dictate that P2P platforms must have run-off procedures in place in case of platform insolvency, however, it would be naïve to disregard the potential for capital loss in this scenario, again highlighting the importance of diversification.
- Cash drag – When investors funds are unmatched, no interest is generated. This is called ‘cash drag’ and can occur if investor demand outweighs borrower demand.
- Illiquidity – When you invest in a P2P loan, you are contractually committed to waiting until the end of the loan term to receive your capital back in full. Whilst a number of platforms offer secondary markets which enabling early access to cash, this relies on sufficient investor demand. Investors should therefore not invest funds where immediate or short term access to funds is required.
Equity crowdfunding investments (unlisted businesses)
- Failure rate – Most start-ups fail, often resulting in total capital loss for investors. There are relatively few examples of successful equity crowdfunding campaigns which have generated strong returns for investors. Those which have (e.g.
- Illiquidity – Unlike listed stock investments, investments made via equity crowdfunding platforms such as Seedrs and CrowdCube are totally illiquid. This means if you want to sell your shares, you are unlikely to readily find a willing buyer (unless you find someone privately).
- Lack of dividend payments – Most start-ups listed via platforms such as Seedrs or CrowdCube are unlikely to pay dividends for a number of years as funds are often required by the business to drive further growth. You should also be aware that further equity offerings are likely to be made which would result in the dilution of your shareholding.
- High valuations – Finally, valuations proposed via crowdfunding websites are often very high given lack of track record, driving increased risk of capital loss.
Equity crowdfunding investments (property)
- Property market valuations – The overall level of return is highly influenced by the state of the property market. If the value of the underlying property increases, investors would likely benefit from capital gain. Conversely, if the property value decreases in an economic downturn, investors would likely suffer capital loss.
- Tenant issues – The property tenants may fall into arrears, causing temporary loss of income.
- Maintenance/renovations – The property may require renovations (e.g. faulty boiler) which could reduce income distributions.
- Rental market rates – Expected rental rates may not be achieved, resulting in reduced income.
- Lack of control – Investors are not involved in the day-to-day decisions involving the property (e.g. decisions such as when to sell the property are likely to be outside of the investors control).
Firstly, my opinion is just that, my opinion. It should not be taken as financial advice as I do not proclaim to be a financial advisor.
Having said that, I believe that peer-to-peer debt investments made with some of the more established P2P lending platforms are far less risky than equity crowdfunding platforms such as Seedr’s and Crowdcube. When investing on these platforms, your cash is tied up with little hope of return unless the business is acquired by another company or the company decides to IPO. Very few investments on these platforms deliver any profit (by way of dividends or capital growth). In fact, Seedrs’ themselves state “it is significantly more likely that you will lose all of your invested capital than you will see any return of capital or a profit”. For this reason, I have not and do not intend to make any investments via these platforms.
Peer-to-peer lending is probably also less risky than property crowdfunding as whilst property crowdfunding offers the potential for capital gain, it also offers the potential for capital loss. Property crowdfunding is akin to self-investing in bricks and mortar, but with some recognisable upsides (reduced hassle, potential to dispose easily via secondary market) and downsides (fees, lack of control). Dividend income is typically generated via rental returns, whilst the overall return is influenced by the capital gain/loss generated which is influenced by external property market conditions. However, unlike equity crowdfunding for unlisted businesses which features the risk of total capital loss, the capital loss risk is reduced in property crowdfunding. If you want to find out more, read our Property Partner review.