There are many different types of crowdfunding models available; some rely on donations from individuals to community projects or charities (donation-based models); others offer rewards to the members of the public in return for them pledging support by giving money (reward-based models).
However, the two which are of most interest to investors are investment-based crowdfunding and loan-based crowdfunding; the latter is also known as peer-to-peer lending. The two different terms are often used interchangeably to describe the same business model.
What is peer-to-peer lending and how does it work?
The principle behind peer-to-peer lending is to bring together people who have money and want to invest (“lenders”) with people who want money but have to borrow (“borrowers”).
Those individuals that have money are looking for an investment opportunity that will generate a commercial return. The people that need money can be entrepreneurs and companies looking for finance to develop their business plans or ideas (“business lending”). However, this group can also include individuals who need to borrow money to buy a home or a car (“consumer lending”).
So, the P2P lending model was established to connect lenders and borrowers through the use of an online marketplace, known as a platform. In effect, the operator of the platform (the P2P lender) acts as an intermediary between both lenders and borrowers.
One of the leading P2P lenders – folk2folk- has produced a very useful Mini Guide which provides a very helpful overview of the lending activity.
What is the role of a peer-to-peer (P2P) lender?
The role of the P2P lender is two-fold:
The first is to identify and source a pipeline of suitable borrowers, and conduct an appropriate level of due diligence to ensure those borrowers have the ability to repay any loan offered to them.
The second is to promote lending opportunities to investors, arrange the collection and disbursement of funds, manage the loan portfolio (or the outsourced loan administration provider) and provide regular updates to investors.
P2P lenders will quite often choose to focus on a particular area of the lending market. For example, some will only lend to small, and medium-sized enterprises (SMEs), others will focus on the property sector only. The property sector in turn might be further split between bridging finance, home finance or development loans. Loans might be offered on either a secured or an unsecured basis.
The lending marketplace is quite a complex environment, so it makes sense for each online platform to specialise in one area of finance. The approach and expertise needed for business lending (loans to develop a new product), property lending (bridging finance) or consumer lending (car loans for example) can be very different.
What’s the appeal of investing in peer-to-peer lending?
If you are thinking of investing in peer-to-peer lending and want to learn more about the pros and cons of doing so, then please click here.
