Peer to Peer and crowd funding
As already mentioned in the property page here, peer to peer (P2P) and crowd funding websites and platforms, have revolutionised the way and types of investments that can now be made.
P2P lending and equity investing allow you to earn an income and make money by helping other people, businesses, or property owners, with their money needs.
In simple terms, the “people” or “crowd” are pooling their funds together and standing in the place of banks, and other lenders. This arrangement should hopefully enable investors to earn more interest than they would in a savings account, and borrowers should pay lower interest rates than the banks would have charged them, so a “win-win” situation all round! (Except for the banks of course).
P2P is now over 15 years old, and the original platform called ZOPA (Zone of Potential Agreement) is still in operation and thriving, which is good news.
The P2P industry has been growing rapidly over the years, and now hundreds of thousands of investors lend more than £3 billion each year, via their P2P accounts.
You can lend to both businesses and individuals, sometimes backed by security, and sometimes not. You can even choose to lend to prime borrowers or high-risk borrowers, or a combination of all types of borrowers.
Sometimes you are just issuing debt, sometimes buying equity, and sometimes a mixture of both. There are many ways of getting involved in the new digital P2P investing game.
The following are some of the types of investments you can make on P2P platforms:
Small business loans.
Mortgages to buy-to-let landlords.
Loans to property developers.
Short-term (bridging) property loans.
Loans for sustainable energy projects.
Equity investments for property development and sale.
Equity investment for property development and rental.
Equity investment, or seed capital in start-up businesses.
By way of an example, one such platform may operate like this, in respect of personal loans.
Chloe invests £1,000 onto a platform and decides to loan this money to 10 different people, with varying risk categories ranging from A* to B and C. The platform then calculates the likely return, using the current interest rates, the spread of risks chosen, and also a prudent bad debt provision.
(It is worth noting that some platforms also have a bad debt fund that can be tapped into if one of your loans goes wrong, so it’s worth taking a close look at this provision before you choose any P2P platforms to invest with.)
Once the loans begin, Chloe should then start to enjoy monthly payments of both capital and interest, that she can reinvest if she wishes into new loans.
This process will continue until the loan terms of either 12 months, three or five years have expired, or there is a problem with one or more of the loans.
Any loans that default, (don’t pay on time) are handled by the platform providers, and to be fair, they generally have a good system and process in place to recover the outstanding money quite quickly. It’s the same process the banks use.
If this intervention does not succeed for some reason, they are also able to go down the legal route to enforce payments if needed.
If ultimately the platform owners are unable to recover the monies owed by the defaulting borrower, then there is a risk that the investor may not get back some of his interest and capital, or potentially all of it, although as we have noted earlier, bad debt provision funds are usually on hand to soften any potential loses.
As you will already understand, the higher the potential interest rate, the higher the risk, so whilst A* loans are considered the lowest risk exposure, if you choose to lend your entire investment to category C risk borrowers, you should expect to see some defaults.
In a similar way that cash and stocks and shares ISAs provide a tax-free wrapper for those investments to grow free of tax, there is also a similar scheme available for P2P and crowd funding lending, called an IFISA, or Innovative Finance ISA.
These should be used to help your investment grow as quickly as possible, but be aware the overall ISA allowance includes any IFISA investments, they are not in addition to your other ISA’s.
High net worth & sophisticated investors
It is useful to know, albeit somewhat frustrating, that there are some investments in the UK P2P market (and the USA) for that matter, that you are not permitted to invest in unless you can self-certify that you are a high net-worth investor or a sophisticated investor.
If you earn at least £100,000 a year or have net assets, excluding property and pensions, of at least £250,000, you can self-certify yourself as a high net worth individual.
To class as a sophisticated investor you must:
have made at least one investment in an unlisted security in the previous two years; or
have been a member of a business angels network for at least six months; or
have worked in a professional capacity in the provision of finance to SMEs in the last two years or in the provision of private equity; or
be or have been within the last two years, a director of a company with a turnover of at least £1m.
These rules are imposed by the Financial Conduct Authority (FCA) in the UK and the Securities and Exchange Commission (SEC) in the USA.
They are in place to protect investors from potentially risky investments, in which new investors could lose their whole investment.
As a young investor, or new investor, you are not likely to satisfy any of these requirements immediately, but one day you will, and then you can cautiously try out this niche class of investing.