The peer-to-peer lending sector in the United Kingdom is much larger than the equity crowdfunding sector. There are many reasons for this, not least of which is the significant demand from consumers and small businesses for credit that is not fulfilled by the banks in the country. But another less obvious reason is that there is also much more demand from investors for fixed-return loans than there is for equity investments.

The fixed interest payable on loans distributed on peer-to-peer lending platforms not only clarifies the return that the investor can expect but also the risk that the investor is taking on. Some lending platforms such as FundingCircle even assign a risk rating to each loan sold. Even in the absence of a explicit risk band, a higher interest rate on the same platform usually signifies a riskier loan. For example, lenders can choose between two types of loans on Unbolted and loans that pay 8.00% annualised are a little less risky than those that pay 10.50% annualised.

Lenders also compare the interest rate on peer-to-peer loans to the interest rate that they earn on their bank accounts. In fact, some peer-to-peer lending platforms offer products, such as Assetz Capital’s ‘Quick Access Account’, that are very similar in terms of customer experience to a bank deposit (with the significantly higher rate of return and risk of course).

It is also much easier for lenders to plan for how long their investment is likely to be tied up for. A lender who wishes to tie up his capital for a short period of time can choose a short-term loan on platforms such as Unbolted or Market Invoice. On the other hand, a lender who wishes to lock in the rate of return for a longer period of time can choose loans with maturities as long as five years on platforms such as Ratesetter.

When it comes to investing in equity in startups or unlisted companies, it is much harder for investors to evaluate exactly what return they can expect. It is also much harder for them to differentiate between the risk of the various investments on offer. In the case of unlisted companies, it is also difficult for investors to evaluate when they may expect a return on their investment. The absence of a secondary market on these investments makes it extremely difficult to exit the investment.

None of this means that equity crowdfunding is unsuitable for investment. Equity crowdfunding provides the man on the street with the opportunity to invest in early-stage startups in a diversified manner without having to allocate a large amount of capital to one investment opportunity. However, it is a much riskier segment of the new decentralised financial system which will form a much smaller proportion of most investors’ portfolios than peer-to-peer loans.

Founders Blog
11 Nov 2015
Ashwin Parameswaran