Join the in-crowd with peer-to-peer lending

It’s an innovative form of investment – and carries its own risks – but many are now reaping rewards

A SQUEEZE on lending to businesses by banks and poor interest rates paid on savings have fuelled the peer-to-peer and crowdfunding investment craze. With plans afoot to allow savers to shelter these investments in tax-friendly Isas before the end of this year, SALLY HAMILTON investigates whether more people will choose to follow the crowd.

LENDING to friends and family is generally to be avoided but thousands have taken the risk a step further and loan cash to strangers through a new wave investment – peer-to-peer lending. Known as P2P, the phenomenon has become a lifeline in the past few years for many savers struggling to find decent returns on their money, not to mention loan-starved companies.

Savers ‘lend’ money to individuals or businesses at a rate they choose, cutting out the middle man of the bank or building society and, as a result, typically earn higher returns.

Demand for the people power of P2P has soared, with funds invested doubling from £666 million last year to £1.74 billion in 2014, according to a recent report published by innovation charity Nesta and the University of Cambridge.

And if plans materialise to bring at least some of the options under Isas, they should flourish further. Nesta found that 65 per cent of lenders expect to commit more cash to P2P if the lending qualified.

Here, we examine the three main types of P2P – with differing levels of risk.

RISK LEVEL LENDING TO INDIVIDUALS

THIS is the lowest risk arrangement where a saver, or ‘lender’, loans cash to other individuals and can earn rates of up to 5 or 6 per cent a year – double the best rate found by scouring savings account comparison charts.

The deals are arranged through online platforms where individuals each lend a small amount to many borrowers taking out unsecured loans over a set period, typically for a purchase like a car.

To protect savers, platforms typically offer loans to borrowers who are good credit risks. One of the biggest players, RateSetter for example, rejects five out of six loan applicants, which means its bad debt rates hover at around 1 per cent.

The industry, which is less than a decade old, suffers because investors are not protected by the Financial Services Compensation Scheme as they are with savings, where up to £85,000 held with a bank or building society is protected.

But Rhydian Lewis, co-founder of RateSetter, says several providers have addressed concerns by offering their own protection funds. He says: ‘Every borrower with us must pay into a central pot an amount that depends on their risk profile. Any missed payments to lenders are paid from this.’

Bad debts are spread among all savers and a third party will try to recover the debts to replenish the protection fund.

Lenders can also trade in their loans at any time for a fee – although the money they get back is not guaranteed. Newcomers to saving this way should opt for a provider that is a member of the trade body P2P Finance Association (P2PFA) as they agree to meet strict criteria on consumer protection. Key players: Zopa, RateSetter, Lending Works.

RISK LEVEL LENDING TO BUSINESSES

A RISKIER form of P2P is lending to businesses. Providers act as an online dating agency between lenders and small and medium sized businesses, with numerous lenders typically con- tributing to a single loan and spreading their own money across scores of business borrowers.

The concept is the same as for P2P for ordinary borrowers but small businesses are far riskier and more likely to miss payments or go bust.

This means rates paid to lenders are higher – sometimes as much as 12 per cent. The more established players offer only secured business loans, which give some measure of protection but borrowers can still lose all their money. ThinCats, which offers lenders 10 per cent on average, says its default rate since launch in 2011 is less than 1 per cent.

With FundingCircle, for example, savers who feel confused about the choice can opt for an ‘autobid’ which spreads the risk on their behalf.

Would-be P2P lenders to business investors should consider going through members of the P2PFA because of the provisions they have in place for continuing loan repayments when a business defaults. Some players, including ThinCats, only offer secured busi-

ness loans to add a layer of protection.

Landbay lends only to residential buy-to-let landlords, with loans secured by first-ranking mortgages on tenanted properties.

Andrew Hagger, independent analyst at MoneyComms, says the returns on offer from Landbay are lower, but adds: ‘The overall risk management initiatives to protect customers’ money are the most comprehensive in the market.’

Another variation is to invest into a ‘debenture’, a type of IOU issued by companies that also pay you interest called a ‘coupon’ on your loan. Examples include Abundance Generation’s renewable energy projects.

The latest is its £3 million solar energy scheme – Oakapple Berwickshire – to put solar panels on roofs of social housing properties in Berwickshire in the Scottish Borders.

Investors can put in from £5 and earn 7 per cent a year initially, rising to 7.5 per cent when the project is fully up and running.

Since capital and interest will be returned over 20 years this is essentially a long-term commitment. The loan can be sold through Abundance Generation’s bulletin board, a sort of eBay marketplace, although a buyer is not guaranteed, nor is the price.

Key players: Funding Circle, ThinCats, Landbay, Abundance Generation, Trillion Fund.

RISK LEVEL EQUITY CROWDFUNDING

EQUITY crowdfunding is the riskiest form of P2P. While it also links up investors online with businesses in search of cash, this time it is in return for a stake in the company instead of an income.

Investors hope their stakes will grow in value. Dividends are unlikely and there is no protection from the FSCS if a business goes bust.

Crowdfunding is more suited to sophisticated investors and is popular because most deals offered are eligible for big income and capital gains tax breaks under the Enterprise Investment Scheme or Seed Enterprise Investment Scheme.

Would-be investors compare online pitches and commit an amount towards a fundraising target. If the equity seeker fails to raise the target figure, investors get their money back and can invest it elsewhere.

Jean Miller, chief executive of crowdfunding platform InvestingZone, warns of the pitfalls, not least falling for overly slick pitches.

She says: ‘You need to check the shareholders’ agreement otherwise you can end up investing in a successful company but still receive little or no return.’

Miller adds: ‘Check for pre-emption rights. Without them you will not be able to buy new shares and see your own holding reduce in value. Also check voting rights, without which investors may not be able to force a company to sell up so they can realise their gains.’

Because equity crowdfunding is eligible for its own tax breaks, it will not be among the P2P investments allowed in Isas next year. Key players: Seedrs, Crowdcube, InvestingZone.