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How To Pass CapitalStackers’ Appropriateness Test
You'll be asked to pass an appropriateness test (investor test) before lending through CapitalStackers, as with all P2P lending platforms.
Who can lend through CapitalStackers?
I'll come to how to pass the test in a minute. Firstly, here's how to lend through CapitalStackers without restriction.
CapitalStackers* can be used by all investors. You can lend through CapitalStackers with no restrictions if you are:
- A self-certified sophisticated investor. At CapitalStackers it's not as easy to self-certify compared to most P2P lending websites. It uses the older definition of self-certified sophisticated investor – which means your P2P lending experience doesn't count. The easiest way to qualify – bizarrely – would be to invest a small amount of money by buying shares in two startups through a crowdfunding website such as Seedrs, where the minimum investment is just £10.
- A high net-worth investor – with £100,000 income or £250,000 in wealth.
- The recipient of professional financial advice about peer-to-peer lending through CapitalStackers.
If you don't fit those categories, you're supposed to restrict yourself to investing no more than 10% of your wealth (excluding your own property) in either peer-to-peer lending or equity crowdfunding combined. This is potentially more restrictive to you than normal, because most P2P lending websites apply the limit to P2P investments only.
How to pass CapitalStackers' Investor Test
Whatever your category and however much you want to lend, CapitalStackers has a test for you. The test is shown below. In it:
- The bold answers are the correct ones.
- Just one answer is correct for each question.
- You'll be asked 10 questions out of a pool of the 17 questions. You need to get 8/10 correct. Plus, four of the questions are compulsory and you have to get them all right.
- After each question, inside the gold lines, I provide more information if you need help understanding the questions and answers – and understanding CapitalStackers better.
CapitalStackers* gives you three chances to pass the test, but you can have another go after it offers you further support in understanding what you're doing.
About 4thWay's series on How To Pass The Appropriateness Tests
Warning: taking these appropriateness tests (investor tests) can cause pain or boredom! So, while 4thWay users are far more knowledgeable than most, we want to make things quicker, simpler, more educational and more understandable for you. You get plenty of help below. And you get plenty more help for many other peer-to-peer lending and IFISA providers in our How To Pass The Investor Tests series.
I'm sure I don't need to ask you to please make sure that you do your research thoroughly on all peer-to-peer lending and IFISA providers. You can do that by reading 4thWay's guides and provider reviews, and by looking into the opportunities for yourself.
If you can't correctly answer the questions in an investor test by yourself, you probably need to do a lot more research. Because the questions they ask cover just the bare basics about how they work. The tests don't inform you about how good they are at appraising potential borrowers or any of the other essential tasks they have to do on lenders' behalf. So arguably the most important bit is missing!
Below are all the questions and answers in CapitalStackers' investor test, including the correct answers. The questions might not be shown in the following order.
Bonus tip: at the time of writing, in CapitalStackers' quiz, the correct answer is always the longest answer, except for the question about the Financial Services Compensation Scheme!
Q1. Which of these statements best describes your relationship with CapitalStackers?
- CapitalStackers – whose duties and responsibilities are defined in the Lender Terms & Conditions – provides origination and administration services, managing my loans on my behalf.
- I have no relationship with CapitalStackers; my relationship is solely with the Borrower.
- I have no say in the management of my loans.
As with all peer-to-peer lending, the lenders have no responsibility for finding and approving borrowers (so-called origination) or managing loans. CapitalStackers does that for you.
Q2. Which statement best describes your relationship with the Borrower?
- I have no relationship with the Borrower because my lending is to CapitalStackers.
- I have a direct relationship with the borrower but Capitalstackers Trustees Ltd is appointed as my attorney and agent (under the loan documentation entered into with the Borrower).
- I have a direct relationship and can take direct unilateral action against the Borrower to recover my loan.
Your investments through CapitalStackers involve lending directly to the end borrowers – the property developers or owners. Indeed, by 4thWay's definition, peer-to-peer lending is always lending directly to the borrowers.
Because if you were instead to lend to CapitalStackers, who then lent to the property borrowers, that would potentially increase your risk of losses in the event that CapitalStackers builds up other debts and then goes bust.
Note though that in the past some businesses have called themselves peer-to-peer lending even when there's no direct relationship. Always check whether you're lending directly or not. 4thWay only lists opportunities that we consider to be genuinely P2P.
Q3. Which sentence best describes the most likely outcome if the Borrower goes into Administration?
- I will lose all my capital and the security will be sold.
- I could lose some or all of my capital but CapitalStackers – together with any senior lender – will have “step-in” rights to take control of the property and building contract, and to appoint professionals to manage an optimum outcome.
- I cannot lose any capital as CapitalStackers Trustees Ltd have a charge over the property assets.
I don't think this question requires much explanation, but to ram it home: obviously there are risks of losing money if a loan turns bad.
But since CapitalStackers* has the skills and contacts to ensure a development project is completed, and since it's able to sell the land and property to recover bad debt, your risk of losses is clearly reduced.
I consider CapitalStackers' team to be highly competent and expect excellent results in turning bad debts back into good ones.
Q4. How much of your capital invested through CapitalStackers is at risk?
- All my capital is at risk because in some circumstances amounts realised from assets may not be sufficient to repay my loans.
- Only some of my capital is at risk because it is unlikely all security will turn out to be worthless.
- None of my capital is at risk because the loan to value ratio will not exceed 75%.
All your money is lent out and so all of it is “at risk”. If you were to put your money in the stock market, it would also all be at risk.
Q5. If you were to incur a loss through CapitalStackers, how much would be covered by the Financial Services Compensation Scheme?
- None. Peer to Peer lending is not covered by the FSCS.
- All capital and interest.
- Only the capital because interest is not covered by the FSCS.
This is the one where the longest answer is not the correct one.
Q6. Does your development loan rate of return vary depending on the timing of repayment and whether there are any extensions to the loan term? If so, how?
- It doesn't vary because the rate of return is agreed with the Borrower as an annualised rate, compounded monthly so interest accrues up to the date of repayment. That means the return is fixed.
- If the development performs well, there will be more funds to distribute so I will get a better return.
- My return will reduce over time because the risk decreases as the Borrower builds out the scheme, finds buyers and pays down the loan.
Woah there! You need a little bit of a maths head to get that jargon. I'll give you a simplified example.
If you lend £10,000 in a one-year loan that pays you 7% per year, you'll earn £723. That's not 7% of £10,000, which is £700. Because when you earn interest after month 1, you start earning interest on top of that interest. So each month you earn more interest on top of interest. That's what compounding is.
If you lent with a 7% annual rate, but the loan is just for six months, you'll only reach £355 in earnings by that point.
Or if you lend for 18 months at 7% annual interest, you'll earn £1,104.
In all three cases, you've been earning 7%, but you've earned different amounts because you weren't always lending for exactly one year.
Q7. Which statement best describes the comparison of P2P with a savings account at a High Street bank?
- They are similar in that both offer a guaranteed fixed rate of return.
- There is no risk of loss from a bank savings account below the FSCS threshold. With CapitalStackers the returns are higher to reflect the higher risk of default.
- Both offer good liquidity and immediate access to cash.
Firstly, I have to disagree that there is “no risk of loss” from savings under the FSCS limit. But the risk is minutely small. It would happen due to such extreme events that it might not be your biggest worry at the time anyway.
All investments – including money lending – have risks. If the risk were as small as they are when you leave your money at the bank, then the interest rates would typically be lower than inflation – just as they are with savings accounts.
Savings differ in another way: ease of access. Many savings accounts are designed to offer immediate access in the event you want to withdraw your money. And it's almost a certainty that you'll be able to get all your savings back right away. In contrast, there's no investment where instant access to all the money you invested is such a natural and certain phenomenon. Either you have to accept wild price fluctuations – such as with the stock market – or your money might get tied up for longer.
The natural investment horizon for P2P lending is the length of the loans. CapitalStackers has a very interesting secondary market – which is where you can buy and sell loans before they are repaid by the borrower. But it's not a guarantee of early access.
Q8. How does the security of a second charge over a property mitigate risk?
- Security over a property ensures that it cannot be sold without the lender releasing their charge.
- This provides a control mechanism for the distribution of revenue when a property is sold. A priority deed regulates the distribution of revenue in situations where there is a senior lender (usually a bank) and a junior lender who will receive sales proceeds only after the senior lender has been repaid. Only when the junior lender is repaid will the Borrower receive the surplus.
- The Borrower is obliged to repay the loan irrespective of any security, so the security does not affect the risk.
The “charge” tells you whether you'll be first, second, third or even later in line to get your money back when a loan goes wrong.
CapitalStackers mostly does second-charge lending. I'll give you an example contrasting it with first-charge lending so you can picture the risks.
If you and other lenders lend £75,000 to a borrower who's property is valued at £100,000, and you are the only lenders, you will likely have a first charge. If the loan turns bad and in the end you're only able to sell the property for £60,000 after costs, you and the other lenders will collectively lose £15,000. You'll have £60,000 though, so you'll each get back 80% of your money (£60,000 out of £75,000).
If you lent to the same borrower, but you just lent £25,000 and a bank with a first charge lent the other £50,000, this is a very different picture. The bank would get all its money back. You and the other P2P investors would get back the remaining £10,000. But you lent £25,000, so you each lose over half your initial loan.
It's vital with this kind of lending that all the right steps are taken to reduce the risk of a property project going wrong and of any rapid, forced sale resulting in too low a price to recover all or most of the debt. This requires experience, which I believe CapitalStackers has a great deal of.
Q9. How does a financial guarantee work?
- A lender can call upon a guarantee where a borrower has defaulted on the loan – for example, to meet cost overruns. This gives the lender additional comfort where the borrower is a single-purpose company set up for a specific project.
- The guarantor can be asked to repay the loan at any time where a lender perceives there to be an adverse change in risk.
Guarantees can be good additional protection for lenders and yet they can also prove to be of little use. The value of a borrower's guarantee is uncertain until CapitalStackers demonstrates it in practice when loans go bad and property sales don't recover all the outstanding loan and interest.
I think this won't happen often due to the quality of these loans, so we might have a long wait to see the usefulness of CapitalStackers' borrower guarantees. That said, I would expect better guarantees in this kind of lending and from the team at CapitalStackers* than, say, in unsecured business lending.
Q10. What does risk diversification mean in the context of CapitalStackers?
- I can spread investments across a number of different deals when lending direct to Borrowers, so that any losses are confined to a smaller percentage of my investment portfolio.
- I do not need to consider diversification given the level of risk analysis and due diligence you undertake for each deal.
I hope it goes without saying by now for all 4thWay readers that you must spread your money widely across lots of P2P lending websites and a huge number of loans, and also look to put money in other investments too. This is the single subject that the writers and specialists at 4thWay mention most frequently, and for good reason.
Q11. What is the more important significance of Loan to Value ratio?
- It is the key risk measure against which pricing is determined.
- It is a key risk measure as it demonstrates how much the valuation will have to fall before sales proceeds are insufficient to repay capital and interest in full.
In my example in question eight, I mentioned a loan of £75,000 against a property valued at £100,000. This would be a 75% loan-to-value ratio. The lower, the better. You want to be sure that the property has been valued by a suitable expert.
Some properties are far easier to value, such as ordinary residential property. Because you can't always easily estimate in advance how much a marina or a farm is going to sell for. If it's easier to value, it's generally safer for lenders.
What's also important is how the loan-to-value is measured. Is it measured against the hoped-for sale price of a completed development? Or is it based on the initial or current value? For example, the £75,000 loan might be against an expected sale price of the property of £100,000 after the development is completed. But the current value of the property might just be, say, £80,000. So the loan to value at the start of the loan would be 94% on that basis.
You also want to know if the valuation is based on having all the time in the world to sell, or does it more conservatively assume that the property will be sold in a forced, quick sale? And is such a quick sale seen to be the most likely exit if a project turns bad and can't be saved?
These are all the sorts of questions that should go through your head when selecting loans yourself through CapitalStackers. Familiarise yourself properly with some of your first loans by asking CapitalStackers questions.
Q12. How does CapitalStackers mitigate risk?
- At CapitalStackers, you undertake rigorous analysis, harnessing information from the borrower and through the due diligence process. This enables you to analyse the risks and security to structure the funding with an acceptable risk profile. Once the loan is drawn, you regularly monitor performance and manage proactively to ensure that any deterioration in risk is picked up early and remedial action taken.
- You rely on the senior lender to undertake due diligence and ongoing monitoring.
- You only take your margin and exit fee after my fellow lenders and I have been fully repaid.
The argument is that when there are two businesses assessing borrowers (in this case a bank and CapitalStackers) then assessments are more reliable. There's going to be at least some truth in that. But lenders through CapitalStackers are mostly relying on its in-house assessment, monitoring, and any necessary remedial action.
On that last point – remedial action – CapitalStackers has already demonstrated thoughtful and experienced action when developments have suffered issues, ensuring that projects have been completed with profits for the borrower and full returns to lenders.
Q13. Why do we raise the whole of the CapitalStackers funding and have the senior debt fully committed at the start of a project?
- This is done so that I can earn more interest.
- This is done to ensure that sufficient funds are available to meet development costs so that the project is assured of reaching practical completion, without the need for further funding being sourced.
It's usual for development projects to have their loans paid out to them in tranches, as and when they successfully complete different phases of the project. This ensures borrowers don't blow the entire loan recklessly or ineptly.
However, it still makes sense to raise the entire funding amount in advance. This is so that a good project that's already underway doesn't go under, just because there aren't enough lenders around to supply the remaining required funds. Not all P2P development lending platforms follow this best practice, but CapitalStackers* does.
You earn interest on the full amount lent, even if the borrower has not received all of the loan tranches yet.
Q14. Why do the different Layers in a deal offer different interest rates?
- To give me a choice of returns.
- To ensure that rewards are appropriate to the level of risk. Layers with higher Loan to Value ratios offer a higher reward. Lenders in lower layers receive all their capital plus accrued interest before lenders in higher layers.
CapitalStackers' “layers” is similar to the first-charge/second-charge business covered in question eight. But here, CapitalStackers splits CapitalStackers own lenders into further divisions. Here, some CapitalStackers lenders choose to take the riskiest portion of a second charge. (Some lenders lend in multiple layers of the “stack”.)
Clearly, if you're going to lose your money before others, you want to earn higher interest rates.
Q15. True or False: You can get your money back at any time through the Secondary Market.
- True. The secondary market allows me to sell to another investor at a price I choose – to reflect capital and interest accrued.
- False. Whilst there is a secondary market, there may be occasions (such as imminent repayment or a risk alert on a deal) which will limit the appetite of potential buyers. Moreover, secondary market sales are reliant on buyer availability and demand, neither of which is guaranteed.
If you lend money, you have to expect that sometimes some of it will take longer to get back to you than you hoped. You can improve your chances of having more of your money come back early, but don't lend if immediate access to all your money is important to you.
An advantage of CapitalStackers is that its loans tend to be relatively short term, so you generally expect your money back on them within a year or so.
Q16. True or False: You will always get your money back on the documented loan expiry date.
- True. The Borrower's loan agreement provides for a certain loan period and the borrower is obliged to repay the loan at expiry which always happens.
- False. Repayment usually depends on the timing of practical completion and sale of a development and delays are often encountered. Loans can sometimes be repaid early and often are repaid late. CapitalStackers provides investors with regular updates on the anticipated repayment date.
Seems clear enough to you, right? I'll just add that you continue to earn interest until the loan is repaid.
Q17. How will your loan be affected if CapitalStackers ceases to trade?
- My loan will become immediately repayable, which may adversely impact the project and the risk will increase.
- My loan should not be materially affected. The ongoing management and administration of the loan will be undertaken by Hallidays Chartered Accountants pursuant to a formal agreement.
Hallidays is another business operated by at least one of the directors. With CapitalStackers being quite small, it will require low costs and little time to wind down existing loans. Its plan for winding down is appropriate.
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Independent opinion: 4thWay will help you to identify your options and narrow down your choices. We suggest what you could do, but we won't tell you what to do or where to lend; the decision is yours. We are responsible for the accuracy and quality of the information we provide, but not for any decision you make based on it. The material is for general information and education purposes only.
We are not financial, legal or tax advisors, which means that we don't offer advice or recommendations based on your circumstances and goals.
The opinions expressed are those of the author(s) and not held by 4thWay. 4thWay is not regulated by ESMA or the FCA. All the specialists and researchers who conduct research and write articles for 4thWay are subject to 4thWay's Editorial Code of Practice. For more, please see 4thWay's terms and conditions.
*Commission, fees and impartial research: our service is free to you. 4thWay shows dozens of P2P lending accounts in our accurate comparison tables and we add new ones as they make it through our listing process. We receive compensation from CapitalStackers and other P2P lending companies not mentioned above either when you click through from our website and open accounts with them, or to cover the costs of conducting our calculated stress tests and ratings assessments. We vigorously ensure that this doesn't affect our editorial independence. Read How we earn money fairly with your help.