Crowdfunding (equity) and peer-to-peer (debt) are exciting ways to invest. It’s common to see high net worth individuals including both as part of their portfolio. Yet there is confusion around the differences between the two concepts, particularly with newcomers to the sector.
This is understandable. After all, both follow the same principle: money is provided by investors directly to recipients who need the capital. In both cases investors are looking for a return.
Both are versatile sources of funding. They can be used to raise money for entrepreneurial ventures, creative concepts, social projects, and large-scale commercial propositions.
And both are mature funding categories, regulated by the financial authorities.
And yet they are indeed different. Here’s your guide to the unique characteristics of crowdfunding and peer-to-peer lending.
Do you know where your money is going?
Crowdfunding tends to be directed to a single project. An entrepreneur may need capital to launch a start-up. Or a thriving business may require capital to expand. In crowdfunding the investors know precisely to whom to their cash is headed, and for what purpose.
Peer-to-peer (debt) investing is broader in its range of recipients. A peer-to-peer platform pools the capital of investors into a single fund, and makes multiple loans from this fund to borrowers who usually remain anonymous. Investors may know the risk profile of the borrower, and what security they offer, but their identity and their reason for borrowing is (usually) not known.
Equity versus Loan
A second difference is equity versus a loan. Crowdfunding gives investors an equity stake in the project they back; they literally take ownership of part or all of the project. By contrast, peer-to-peer is a loan; the money will be repaid by the borrower, plus interest, but no shares are involved in the deal.
This difference creates a third distinction. Because crowdfunding is an equity investment, the returns are open-ended. If the project or business in question thrives, the investors benefit as they own shares. Similarly, if the project fails, they may lose their capital. This is the nature of equity investing. The returns are performance related.
Peer-to-peer lending is a loan with a fixed-rate of return. Borrowers pay back the money at an interest rate over an agreed time-frame. The commercial activities of the borrower are irrelevant, so long the loan is repaid.
And the final distinction is time. Crowdfunding lasts as long as the investor holds shares. This can be forever, or until they chose to exit by selling shares.
Peer-to-peer tends to be for a finite period, usually one to five years. When the loan is repaid, the relationship ends.
Investor relations are different
Because crowdfunding involves taking ownership of the project, there is a close relationship between the parties involved. Investors care! Of course they do – their returns depend on the health of the project, so from the start they need to understand the quality of the proposition before them, as an angel investor would.
The crowdfunding relationship works both ways. The people behind the project need to impress investors, and keep them happy. This is why many crowdfunding schemes include additional benefits: for example, film directors raise capital for movies, and will offer investors red-carpet tickets to the premier in addition to share of the profits.
Peer-to-peer lending is a purely commercial transaction. The two parties need never talk, meet, or know each other’s identities.
Choosing between crowdfunding and peer-to-peer
Knowing the difference between crowdfunding and peer-to-peer allows investors to find the platform and proposition that suits their strategy. Do they enjoy researching schemes? Or prefer to leave asset allocation to others? Can they tolerate variable returns? Or is a fixed-rate of return the priority?
It is important to note that the best platforms offer flexibility over investment terms. For example, Property Partner makes it easy to diversify investments for crowdfunding – investors are advised to spread capital across a number of properties. This is unusual for the asset class where traditional landlords often own only one or two rental properties.
Also, Property Partner offers an opportunity to exit via the internal Resale market, which works like a stock exchange. That is a pioneering concept in crowdfunding, ending the concern over investors being locked-in for the long-term.
It must be stressed that investing in crowdfunding and peer-to-peer should be done on regulated and authorised platforms. Property Partner offers both equity crowdfunding and peer-to-peer (debt) investing, and is FCA regulated and authorised.
Both methods of investing offer rewards, and risks. Knowing the mechanics of each allows investors to make the ideal choice for their needs.
Find out more about how Property Partner’s property crowdfunding platform works.
Charles Orton-Jones is a freelance business writer, specialising in business and FinTech. Former editor of EuroBusiness magazine, he now contributes to many newspapers, business magazines and blogs.