Why P2P Lending Is Far Better Than Equity Crowdfunding
What is the one huge difference between equity crowdfunding and peer-to-peer lending?
The risks of P2P lending are generally lower than the stock market.
Whereas equity crowdfunding – buying shares in startups through websites – is among the riskiest investments this side of a scam, making it highly inappropriate for all but the most expert investors.
Lending money as an investment
To put this in perspective, consider some of the highest-risk money lending on offer from viable websites in the peer-to-peer lending industry. I think at the top of the risk list might be The Money Platform, which does peer-to-peer payday loans.
Now, The Money Platform unfortunately doesn't provide 4thWay with enough information to assess the risks and it never makes sense to lend your money when the risks are unknown.
However, it writes on its website that you might expect to lose 15% of all your loans, before interest.
If you look at more typical peer-to-peer lending, including property lending, and loans to creditworthy businesses and individuals, actual losses are usually in the region of 1% to 3%.
Buying shares in startups as an investment
Assuming that The Money Platform one day reveals more information and proves itself to be a competent payday lender, even its rather extreme form of P2P lending is still lower risk than equity crowdfunding.
Of those startups that reach the stage of convincing investors to give them cash in return for shares, up to 60% of them lose investors money, according to Cambridge Associates. This can rise to nearly 80% in extreme times, as it did during the dotcom crash.
I'm not even talking here about some especially high-risk form of startup investing, but just plain average startup investing. This makes the contrast with The Money Platform that much more incredible.
Is crowdfunding even worse than that?
Equity crowdfunding might not even live up to the disappointing results shown in Cambridge Associates research, which was largely based on results achieved by professional investors.
Equity crowdfunding is when even complete amateurs can buy shares in startups, deciding what startups are going to succeed and what a fair price is. However, the financial regulator does not require crowdfunding websites to have a specific level of standards in reviewing opportunities and fact-checking the entrepreneurs' claims.
For example, while you have the serious crowdfunding platforms like Growthdeck and SyndicateRoom, which appear to have the right experience and demonstrate sensible processes, all too often you have crowdfunding platforms that allow startup investors to invest in seemingly anything.
This can be based on little more than the word of the entrepreneurs who are so desperately trying to sell their idea.
Projected returns offer a final clue
I absolutely don't want you to always assume that lower projected returns means lower risk, or the other way round. Because it's not always the truth. (Just look at Wellesley*, for example.)
But, in this case, I think the very wide difference in hoped-for returns between typical P2P lending and equity crowdfunding is perfectly reasonable, loosely correlating with the actual risks.
You can expect good-performing, individual peer-to-peer loans to offer you maybe 5%-12% interest.
In contrast, you are typically told to hope for 5-20 times your returns (500%-2,000%) on startups that succeed when you buy shares through crowdfunding.
That is way more than even The Money Platform, possibly the riskiest of viable peer-to-peer lending websites, which hopes for over 100% annual returns on its good loans (and around just 10% rewards after losses on a basket of loans).
The bottom line – and one more statistic
Most startups fail or perform unsatisfactorily, making crowdfunding very high risk.
Money lending has been a solid way to consistently get a good return on investment since long before peer-to-peer lending was invented. For example, UK banks made money from personal loans every single year for more than 20 years in a row, including during the depths of the 2008-2009 Great Recession.
(Yes, banks lost lots of money during the recession, but that was due to crazy risk-taking and complexity, not due to their bread-and-butter money lending.)
When you lend through P2P, you usually lend to people or businesses that have a proven income, or their property can be repossessed and sold if need be.
When you buy shares in startups through crowdfunding, you might be investing in a business that has had little – or even no – income whatsoever, with a far higher risk of failure, and with little prospect of getting any money back if the business fails.
The opinions expressed are those of the author and not held by 4thWay. 4thWay is not regulated by the FSMA and does not provide personalised advice. The material is for general information and education purposes only and not intended to incite you to lend.
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