Alternative Investment  

Why crowdfunding may not be for everyone

This article is part of
Guide to crowdfunding and P2P lending

"A lot of people have done very well with P2P. What I think people should be aware of, effectively it's more akin to an investment because you're lending your money to somebody else.

"It could be that you're scaling that up and lending it to lots of different people, or to one person; the latter is a much higher risk."

She notes: "When you do that with a bank, the risk is with the bank or building society, they are providing a fixed rate savings rate, and in the worst case scenario the bank goes bust you're protected by the FSCS [Financial Services Compensation Scheme]."

With P2P finance, if the borrower goes bust, or the platform cannot meet its liabilities, you have no FSCS compensation.

In 2016, the most recent data available, £4.6bn was invested in the alternative finance sector, up from £3.2bn the previous year, and £300m in 2011, according to the Cambridge Centre for Alternative Finance.

With peer-to-peer lending, retail investors - and increasingly institutional investors - lend their money for a certain period of time to other individuals or businesses; investment crowdfunding is considered more of an investment in small businesses, either via debt or equity.

P2P business lending is the most popular sector, with £1.23bn being lent in 2016; P2P consumer lending was £1.17bn and P2P property lending was £1.14bn. 

Crowdfunding sees much less money - equity-based crowdfunding received £272m, while debt-based crowdfunding received £79m in 2016.

Alternative finance

But the alternative finance sector has become an increasingly important feature of small business financing. In 2016, 32,800 small and medium-sized enterprises (SMEs) used it, amounting to £3.3bn, and 17 per cent of seed and venture stage equity investment came from equity-based crowdfunding.

The basic principle is that an investor firstly picks the most appropriate platform - deciding whether to opt for lending to businesses, individuals, or becoming a small business investor.

The lender chooses how much he or she wants to invest and how long he or she wants to tie the money up for, as well as an indicative rate.

The platform then attempts to match that up with suitable borrowers, who are looking to pay a certain percentage over a certain period of time, with an appropriate risk profile. Typically, a platform will put together a portfolio of loans based on the profile you have invested, so that, ostensibly, the loan is 'diversified'.

Investment-based crowdfunding puts investors and small businesses together, allowing the investor to buy equity or debt so that they have a stake in the business. This model is viewed by the regulator as much simpler than the P2P model.