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Crowdfunding 101

 

Those of us old enough to remember life before the internet sometimes forget how much life has been changed by it. I’m not going to bore you with a list of industries affected; you’ve seen that list 1,000 times.  What I am going to tell you is that crowdfunding has been made possible by the existence of the internet and is worthy of your consideration for inclusion within your investment portfolio.

Crowdfunding seems to be a catch-all title that covers many different things so as a starting point, allow me to give you a tour of the current UK landscape, so that you might better understand where you might want to put your money to work, to match your investment and risk objectives.

 

The Three Flavours of Crowdfunding – Rewards, Equity & Debt.

 
Rewards

 

Since this is an investment title, let’s not dwell too long on rewards based crowdfunding, needless to say that there’s no better example of the difference between rewards crowdfunding and equity crowdfunding than Oculus.

a catch-all title that covers many different things

Oculus raised money to launch through rewards site, Kickstarter. It offered a t-shirt and early model of Rift, a Virtual Reality 3D headset to 10,000+ backers and was subsequently sold to Facebook for $2bn, perhaps those backers would have liked to have had even a smidgeon of equity in the company at that point. To be fair to Kickstarter, it’s a rewards site, the backers weren’t short changed; they got exactly what they were promised. I still can’t help thinking that had they have been able to take equity instead of the headset their return would have been 145x, the $300 contribution becoming $43,500.

 

Equity


You already know about the concept of equity, with equity crowd funding, each member of the crowd receives a slice of ownership in the company that they invest in.

We can dig into the differences between platforms like Crowdcube, Seedrs, Angels Den & Property Moose in a later article. What you need to know is that not all of the private companies raising money this way are going to make it and that the value of your investment can go either way.

Right now there are just less than 160 private companies raising capital on equity crowdfunding sites in the UK (source: crowdwatch.co.uk). Some are start ups, some more established.

You need to consider that these companies are not easily tradable, so whilst getting in is as a few clicks on your MacBook Pro’s keyboard, getting out may take some time. Its good to know that the vast majority of investments in companies on these platforms qualify for EIS or SEIS tax relief, think of it as the Chancellor thanking you for taking a risk and backing small business, the backbone of the UK’s economy.

 

Debt


Peer to Peer (P2P) lending, also known as Marketplace Lending, another invention that Blighty has given the world is founded on the idea that when people lend to people and cut out the cost of maintaining a bank in between, costs go down which means that the rate that the borrower pays goes down and the rate that the lender gets paid goes up.

Zopa are the people that kicked it all off back in 2005. In addition to increased yields and lower costs for lender and borrower, Zopa are of the opinion that people that have borrowed from people feel more of a personal responsibility to their lenders than had they borrowed from a bank and therefore default rates are also lower.

Using the P2P concept, it is now possible for you to lend your money to individuals and businesses, secured or non-secured, long term and short term.

For example, ArchOver allow companies to borrow against the credit worthiness of their clients by facilitating lending of up to 80% against the company’s Accounts Receivable (AR), backed up by credit insurance to safeguard the investor.

A quick look around the web finds interest rates of 5%, 6%, 7%+ when Bank of England base rate is 0.5%.

A quick look around the web finds interest rates of 5%, 6%, 7%+ when Bank of England base rate is 0.5%.

If you fancy getting exposure to the yields that marketplace lending offers but would prefer to have the loan selection taken care of on your behalf, you can always chose one of the specialist investment trusts, listed on LSE and therefore available through your usual broker, these are P2P Global Investments (ticker P2P), Victory Park Speciality Lending Investments (VPC) and Ranger Direct Lending Fund (RDL) soon to be joined by a new Investment Trust from GLI Finance. The additional benefit of taking this route is that should you need to, you can get out as easily as you can from any other share holding.

What else might you need to know about marketplace loans and their place within your portfolio? The answer is tax efficiency. You can put these investments in your SIPP and since April 2016 within a new breed of ISA, the Innovative Finance ISA (IFISA).

 

Nice Yields, What’s the downside?


The downside is that while you might be tempted to compare P2P loans with savings accounts, they’re not savings accounts and as such carry more risk to your money and are not covered by the Financial Services Compensation Scheme. This having been said, some platforms run provision funds to cover potential investor losses.

Whilst on the subject of default risk, let’s take a second look at Zopa, established in 2005.

2005? That was before the credit crisis, I hear you say, how did it affect them?

Well, Mat Gazeley from the company tells me that ‘Zopa was largely unaffected by the credit crisis due to our conservative underwriting approach. There was a small increase in defaults but nothing alarming when compared to our expected losses.’

He continues, ‘The crisis actually helped Zopa gain more lenders and borrowers as we were able to tell a positive story around responsible lending as more people looked for non-bank alternatives.’

If there’s one thing to take away from this article it’s this, as an Investor, you need to decide how much risk you want to take to get the growth and or yield that you want to achieve.

In future articles, I hope to dive into the fine detail further and help you familiarize yourselves further with these two important new asset classes and the platforms giving you access to individuals and companies looking to raise money without using a bank.

 

 

 

 

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