Peer-to-peer lending: Bypassing the banks


    When internet search giant Google bought a $125m stake in American peer-to-peer finance site Lending Club, it was a sign that this market had arrived.

    While Google’s investment was not particularly unusual in its own right, from Lending Club’s perspective the campaign to attract the search engine was less than ordinary.

    Rather than court a capital investment from the tech firm, the peer-to-peer lender simply wanted Google to become a shareholder and convince its shareholders to sell their holdings. The outcome was that the social lender was valued at $1.55bn after the purchase. Having earned revenues of $34m in 2012, the company is anticipating rapid growth for 2013, having predicted to more than double its revenue to $90m.

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    Currently, peer-to-peer lending platforms, which bypass banks and allow anyone with a bank account to lend money directly to one or more people, make up a small amount of the UK debt market. Total lending is expected to be worth about £500m this year, which is a tiny fraction of the billions lent by high street banks.

    Similarly, the popularity of crowdfunding websites, which make it easy to invest in start-up businesses and small firms, are being seen by some as an alternative asset that can offer high growth potential.

    Until now, social lending and crowdfunding platforms have occupied a small niche in the finance market, appealing to those who like the idea of bringing lending and venture capital to the masses, or bypassing traditional fundraising channels. But as their market share increases and the returns they generate become more attractive, it will be hard to ignore this asset class as investors seek alternative avenues to boost their portfolios.

    Money from the masses

    Peer-to-peer lending and crowdfunding are new concepts in terms of the way they are implemented but the idea itself is not entirely innovative. In North America the public broadcasting system operates through a series of government grants and sponsorships but many of the local television and radio stations hold pledge drives to meet their budgets each year.

    In many ways crowdfunding, explained in Box 1, does the same thing by attracting a large number of people to invest small amounts in a company. Meanwhile, social lending, described in Box 2, exists as an alternative to banks with lending platforms like Zopa and Ratesetter promising better rates than the high street banks for both the borrower and lender.

    For crowdfunding platforms like Seedrs, each investor takes ownership of a small piece of equity in the firm and offers the opportunity for high returns if the company finds success.

    But there are questions that need to be asked. David Petrie, head of the Institute of Chartered Accounts in England & Wales (ICAEW) corporate finance faculty, says it is an important area of finance. However, questions still remain about the model’s robustness.

    “It is high-risk investing. It is also important to differentiate between lending schemes, equity investment ones, reward-based ones and social venturing,” he says, adding, “There are also other well-established routes to backing growing companies, such as business angel networks [groups with money to invest] and VCTs.”