Debt: The alternative lending landscape
Loan-based alternative finance might be victim to sloppy definitions, but it is too significant to ignore
Alternative finance grew by 168 per cent in the UK last year, according to a report by Cambridge’s Judge Business School. While the oft-vaunted equity crowdfunding saw volumes totalling £83m in 2014, debt-based lending, via crowdfunding and peer-to-peer (P2P) platforms, made over £1.5bn available in 2014.
The major categories – person-to-business lending (£749m), person-to-person lending (£547m) and invoice discounting (£270m) – each dwarfed equity. “Debt is huge, and it gets very little coverage,” says Nicola Horlick, founder of Money&Co. “This is a proper asset class and should be considered by investors as an alternative to bonds and cash.”
A PROBLEM OF DEFINITION
But the definitions, differences and ins and outs of this fast-growing industry can be confusing. “The characteristics and risks with debt-based lending vary, and the blanket P2P/crowdfunding labels can be misleading,” says Anil Stocker, co-founder of Market Invoice, an online marketplace which enables companies to sell outstanding invoices to raise working capital.
The difference between a debt crowdfunding platform and a person-to-business (P2B) lender are usually considered cosmetic. There’s “no difference,” says Horlick. Money & Co is often called a crowdfunding platform, but it does the same as P2B lender Funding Circle, she explains.
The problem arises around the lumping together of P2P and P2B – “P2P lending means just that, but it gets applied to corporate lending too,” says Horlick. She favours the nascent US expression “marketplace lending” to “cover the whole lot… but everyone is already confused, so trying to change it may be difficult.”
BIGGER FISH TO FRY
For many in the industry, it’s not worth splitting hairs. “I like to think of peer-to-peer as meaning ‘equal-to-equal’,” says Rhydian Lewis, co-founder of P2P lender RateSetter. “In other words, it’s open to all, but no investor or borrower should be treated differently to any other, whether they’re an individual or a business.” The majority of RateSetters are individuals, but the market also includes sole traders, partnerships and companies as investors and borrowers.
The bigger issue is substance. P2P lenders have had to spend much time and effort explaining how significantly they differ from payday lenders, for example. While the latter often offer borrowers annual percentage rates (APRs) of over 1,000 per cent, RateSetter currently averages around 7.4 per cent. The variety and terms of loans are far greater on a P2P platform, with fixed instalments frequently set by the lender and borrowers themselves. Most P2P lenders also have far higher credit and affordability thresholds, too.
But what matters to would-be investors who are considering marketplace lending? A crucial aspect is whether the debt is long or short term, says Stocker. Market Invoice’s investors are institutions and high net worth individuals – “many come to us because of the short-term nature and high liquidity of our products”. Locking up funds for three years plus is not appropriate for everyone, he points out, “especially if there are under-developed secondary markets”. By the same token, of course, investors may favour debentures with a long time horizon – a 20-year fixed loan could appeal for inclusion in a pension.
Whether the debt is unsecured or secured is also important. RateSetter, for instance, offers both unsecured and secured loans – the latter to SMEs. With secure debt, investors will need to know if the value of the security could change.
As with any investment, the key is diversification – across platforms, products and sectors. “It is vital that risk is spread and the lender should not be tempted to put all their money into one high-yielding loan,” warns Horlick. “Investors should also appreciate the transparency available in the P2P, data-driven model,” Stocker says.
But with new platforms coming to market each week, ensuring robust procedures for data, risk management and, importantly, in debt collection and recovery are vital, he adds. The nature of debt-based lending means that loss rates will only crystallise over a period of time. If a platform can’t demonstrate a track record, it’s a case of caveat emptor – check what policies are in place and do as much due diligence as you can.
STAT OF THE WEEK from CityAMCrowdwatch.com
Powered by Crowdnetic, this crowdfunding information dashboard pulls data from major platforms, showing hundreds of fundraises in real-time.
We pull out one compelling statistic
Healthcare sector firms currently have the highest target raises on crowdfunding platforms, with the average at £250,005