The internet has opened up a whole new world for investors
A WHOLE new financial field has been opened through the internet. Entrepreneurs have bypassed traditional sources of funding to seek private and institutional backing for their projects.
Many ideas are worthy of the popular TV series, Yet instead of just four or five backers, inventors seek many supporters to ensure sufficient finance. The prospect for the investor is exciting as their money could be at the birth of a great idea which will pay handsomely.
Yet it is also one of the riskiest ways to save. It is important to remember that such lending is an investment and not a savings account.
Whilst ISA funds, known as ‘Innovative’, can be approved by the regulator, any money invested is not protected by the Financial Services Compensation Scheme. “This lack of protection means these investments are unsuitable for those looking for security. Those who want safety should usually focus on cash holdings which are protected by the FSCS or NS&I products protected by the Government,” advises Chase de Vere, part of the Swiss Life Group.
However, some sites have introduced contingency or provision funds to pay out in the event of a default.
Like any ISA, HMRC allows up to £20,000 to be invested each tax year which means no capital gains or income taxes are liable.
Some of those seeking help are individuals and others already small firms.
It is estimated that around 150,000 have advanced almost £10bn, enjoying an average 4.6 per cent interest. This is a net return after taking fees and bad debts into account.
The scheme is known either as crowdfunding or peer-topeer (PTP) lending with projects advertised on internet platforms run by the likes of Funding Circle, Landbay, Ratesetter and Zopa. Many investors are attracted by financial technology, such as Index Ventures, an Anglo-American venture capital company.
Each platform vets prospective businesses, employing credit officers who assess new applications and price a loan accordingly.
Like Facebook and Google, the greater information it obtains, the more accurately it can judge its rates, taking a commission on each loan. Such platforms do not lend on their balance sheet and so are not constrained in the way a traditional bank operates.
To date, the sector has been only lightly regulated and the Financial Conduct Authority is worried that those who have secured finance are not in a good position if there should be either higher interest rates or a major economic downturn. There is little transparency regarding credit risk.
Savers though do not have to watch slight changes in Bank of England rates as the loans are not directly affected. Instead, such fluctuations are just one consideration which affect PTP rates with platform demand, bad debt and business trends more significant.
Already there has been a major failure. The Manchester-based lender, Collateral UK, was forced into administration in February. It had promised returns around 12 per cent.
Although it had been loaned £21m, it did not have FCA approval for its operations.
In July the FCA suggested new rules to require platforms to explain how they select clients and protect savers, as well as to spell out the full charges and levels of risk involved.
Eight years ago, one of today’s major PTP lenders, Funding Circle, was founded by three Oxford graduates above a waffle shop. It has lent some £5bn. To show the current buoyancy, over £1bn of this was lent in the first six months of this year.
Following sales in 2017 of £94.5m, up 86 per cent on the previous year, the platform floated on the stock market in September, raising £1.5bn, although some brokers expressed concern over the high float price sought.
It was valued at almost 16 times last year’s revenues whilst its major US rivals – Lending Club and On Deck – are less than twice. It expected many of its 80,000 investors who use its platform to purchase shares.
The money raised is to both expand marketing – where over 40 per cent is spent on television advertising – to attract new lenders and to develop foreign markets, notably Germany, the Netherlands and US. London was keen to list the firm to attract more financial technology companies including the challenger banks Monzo and Revolut.
Crowdfunding money can be placed in two tax-efficient vehicles: an Enterprise Investment Scheme (or EIS) and Seed EIS.
Each brings income tax benefits with 30 per cent for the first and 50 per cent for the latter. Both have exemptions from capital gains tax to reflect the risk factor.
One recent Yorkshire crowdfunding success is Northern Bloc which raised £500,000 in one week to expand its vegan ice-cream business.
In three years, the firm has increased output from one to 20 tonnes a week. Based at a former textile mill in Leeds, it now supplies the Co-op, Ocado, Selfridges and Waitrose.
It chose this route for new finance to encourage investors to engage with its brand and help to push the business forward. It has attracted 250 money angels.
To take a profit, apart from the possibility of a dividend, a business has to have a buyout or public flotation. Investors who backed craft brewer Brew Dog in 2010 had the opportunity sell up to 15 per cent of their shares last year. The firm says the return was 2,800 per cent.
Since savers may to wait some years to realise their cash, quoted annual returns are misleading.
Watch, too, for the class of share on offer. Savers need to ensure they are not disenfranchised by acquiring non-voting stock.
ISA rates of return vary enormously. London Capital & Finance, founded in 2012, has an 8.95 per cent target for a five-year loan whilst six per cent is suggested by both LendingCrowdGrowth and RateSetter over one to three years and five years respectively. This year easyMoney became a PTP provider. It has a £10,000 minimum for its ISA which it expects to return up to 7.28 per cent and with no stipulated loan period.
Similarly high rates are quoted for a minimum £1,000 by both Capital Rise (10-14 per cent) and Property Crowd (7-10 per cent). The loan periods are variable with the first and an estimated four to twelve years with the latter.
Lending works, which started four years ago, has a target 8.7 per cent (minimum £25) but loans through LandlordInvest can reach 12 per cent as the money provides buy-to-let property loans.
PTP has flourished through years of low yield, allowing innovative ideas to reach the marketplace.
Derisory savings rates have encouraged more investors to seek this new route. However, savvy advisers say the risks involved mean only the most hardy should spare more than their loose change.
Conal Gregory is AIC Regional Journalist of the Year.