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What is Crowdinvesting?
Crowdinvesting is a new alternative to stocks and bonds facilitated through an online platform, enabling ordinary people to get access to assets such as real estate, business loans and startups formerly only available to a selected few.
The same way as you can invest in publicly listed companies’ stocks and bonds, you can invest in small companies’ equity (stocks) and debt (loan notes) with crowdinvesting platforms. Most projects available on these online lending and investment platforms are based on the traditional crowdfunding model, where the platform is acting as the middleman facilitating the transactions. This allows entrepreneurs, businesses and ordinary people to get funding directly from other peers without the involvement of traditional banks – a process that is way quicker, often (but not always) cheaper and even includes getting branding exposure to a lot of people that might act as brand ambassadors and customers.
In the beginning most crowdfunding platforms were about donation/reward, but as the market matured and the internet became less of a “wild west”, crowdinvesting platforms started arising. In this article we will explain how the world of crowdinvesting is structured and clarify the most common types of crowdinvesting you need to know before you decide how to start investing with a crowd.
Lending vs Equity Crowdinvesting
When you invest your money, whether it is on the established big financial markets or small new marketplaces, you basically only have two investment options: Lending money to somebody or buying a piece of their business.
Crowdinvesting reflects investment opportunities in your society that was not available before the internet and the world of crowdfunding. As with stocks (equity) and bonds (debt), the world of crowdinvesting consists of debt crowdinvesting aka lending crowdinvesting and equity crowdinvesting.
Equity based crowdfunding, also called crowdequity or by some just crowdinvesting, is the act of buying small pieces of a business together with a crowd to fund the business.
Crowdequity allows investors to get into business investments that would normally require a lot of money if they had to buy on their own or simply just wouldn’t be accessible, for example a residential building with 28 apartments. It also opens for people to invest at an earlier stage in a business that would normally be restricted to capital fonds or venture capitalists.
There are mainly two different ways to buy shares in a business with a crowd: Startup Equity Crowdinvesting and Real Estate Equity Crowdinvesting.
Equity Crowdfunding Pros & Cons
Equity Crowdfunding Pros:
- Sky is the limit: Equity investments do not have a cap on the possible value increase, so it is not unusual to see above 20 % advertised returns with a possibility for more.
- Convenience & diversification: Even if you have the money to buy property yourself instead of with a crowd, you would limit yourself to fewer projects and would have to do all the maintenance.
- Tax benefits: With equity investments you usually first pay tax when the shares are sold.
Equity Crowdfunding Cons:
- Last in line: You will be the last in line for payouts. If the company do not rise in value or create profits, you will not get any return on the investment.
- High risk, high reward: With the chance of a high reward comes a high risk – often when it goes wrong with equity investments it goes completely wrong, and the chance of losing some or all of your invested money is very much present.
- Long & unknown investment duration: Equity investments in small and medium sized companies are usually not very liquid and the holding period usually last five to ten years.
Lending (Debt) Crowdfunding
Lending based crowdfunding, also called crowdlending or P2P lending, is the act of buying small loan notes together with a crowd to fund a borrower.
Crowdlending is the most common way to invest through online platforms and the biggest of the two assets classes in 2019. Lending and borrowing money have been around for centuries, but only a fraction of it has gone directly from individual to individual or business to business. Before crowdinvesting, almost everything went through a traditional bank or a non-bank financial institution.
There are mainly four different types of ways to lend money with a crowd: SME Business Crowdlending, Consumer Crowdlending, Real Estate Crowdlending and Invoice Crowdlending.
Crowdlending Pros & Cons
- Stable cashflow & returns: It is easier to predict compared to crowdequity.
- Less risk: Instead of buying a piece of a company, lending money usually involves less risk, lending with a crowd opens up for wider diversification.
- Short investment duration: The duration of loans are specified clearly, you know how long the investment will run if the loan is paid on time.
- Returns are capped: You know exactly what interest rate you are going to get paid if the loan is paid back in full. In case a borrower misses payments, late fees can increase the return a little bit.
- High maintenance: The administration of borrowers and transactions requires an ongoing maintenance, which might result in high fees. Shorter investment durations mean that the monthly repayments will require you to actively reinvest the money.
- Taxation right away: When lending money to someone you will usually start receiving returns monthly instantly. This also means you’re going to be taxed right away, compared to postponing it till the total return of an investment is realized.
6 Types of Crowdinvesting in 2019
Crowdinvesting is a new market with booming growth rates. In 2019, P2P investors have six different options to start investing online through crowdfunding. Even if you don’t have large amounts of money, it is possible to invest in markets that just a few years ago weren’t available for most people.
1. Startup Equity Investing
It is now possible to invest in startup companies with equity crowdfunding platforms. Equity crowdinvesting is the online process of trading your money with early-stage companies, in exchange for shares representing a percentage of ownership in the business. A shareholder with a partial ownership has the right to profits that might arise if the company succeeds with its business plan. On the other hand, if the company fails, the shareholder will lose some or all of the investment.
Before equity crowdfunding only wealthy individuals, fonds, venture capitalists and business angels could invest in startups. The stock market is open for anyone if they can afford the price of one stock. Likewise, the crowdinvesting platforms are opening the markets for companies that are not yet ready for a public offering – those starting up.
Equity crowdinvesting is helping to democratize both the process of funding capital and the investment market. This is done for funders by opening the door to a large pool of potential investors – “the crowd”. At the same time, for investors, the door opens to a large pool of potential projects and ways to invest in startup equity.
Read more about startup equity investing here: Invest in Early-Stage Startups with Crowdfunding
2. Real Estate Equity Crowdfunding
Real estate crowdfunding is a way for property developers and landlords to raise money. This is done by offering equity in a property to a large pool of investors that each contribute with a small amount of money – instead of one investor with a huge amount. The key difference between traditional real estate financing and real estate equity crowdfunding is that crowdfunding is done online with the platform used to facilitate the process.
Along with the crowdfunding platform, the real estate developers can use social media platforms such as Facebook, Instagram or Twitter to market their projects directly to a much larger audience of potential investors.
Many investors have taken advantage of real estate equity crowdfunding as an alternative method to invest in real estate deals that would not be available without an online platform. Likewise, developers looking to receive funding are benefiting from the many relationships with smaller investors by getting funding faster, saving time and getting access to valuable feedback from the online community.
3. SME Business Crowdlending
Crowdlending or P2P lending is increasingly seen as a viable source of alternative financing by small and medium-sized enterprises and more and more SME’s are lending money through crowdfunding platforms. With the rise of the collaborative economy, ordinary people as well as larger investors are catering to the financing needs of business in areas only banks could do before the rise of crowdfunding.
Before the outbreak of the financial crisis, requesting and obtaining a bank loan had hardly any obstacles. Just a few years after the banking crisis, the picture was very different, and a lot of companies had to find new methods and alternative ways to get financed. The solution for some companies is crowdlending. In crowdlending, their needs for obtaining financing can met through collaboration between peers, without the intermediation of large institutions or companies.
Is it only businesses that can’t get a loan in the bank who uses crowdlending? There are of course some companies using lending-based crowdfunding because it is their only alternative. But good solid SME businesses also benefits from choosing crowdlending over traditional financing methods.
The most important feature is the speed of which a crowdfunding can happen compared to a traditional bank loan. Other features are the possibility of getting direct contact to potential customers for marketing purposes and the ease involved with not having to spend time in bank meetings. As a small company, this can be a big hassle and very time consuming – especially when you just want to focus on your primary work of cutting hair, painting walls etc., and on managing your business, which in itself can be very time consuming.
These benefits for funders also result in advantages for investors that have risk willing capital creating a win-win situation. The investors get comparatively attractive return opportunities, an easy way of achieving diversification in this asset class because of the low minimum investments and they do not have to manage the loan arrangement with documentation, payment processes and debt collection.
4. Consumer Crowdlending
Consumer or consumption crowdlending are usually unsecured loans which do not require the borrower to put up any collateral. It provides financing for personal and household purposes, and while some or all the money are used for consumption, a small part is backed with collateral in a car or a home.
Consumer loans are known as pay-day loans, car loans, student loans, personal loans and home equity loans, and have a very wide range of interest rates compared to 100 % collateral backed loans. Pay-day loans are the most expensive type of loan with the highest interest rates, but often also with the highest risk. Car or home loans can be fairly cheap with low interest rates and low risk.
Lending money to consumption can be a very risky affair, since you are lending money to someone who is going to use it on something that is not a tangible asset. It is impossible to sell a family’s vacation from one year ago or other already consumed intangible “assets”, so these types of loans are all characterized by the fact that the money is going to be used for consumption and the repayments usually rely on the borrower’s ability to generate a salary-based income. Compared to all other types of crowdlending, which usually rely on a business asset to generate income, this type of lending is dependent on a single person or family’s household income.
5. Real Estate Crowdlending
Real estate crowdlending is a way for real estate developers and landlords to acquire a loan for a real estate project instead of offering equity and shares in their company. This type of financing for properties usually requires a certain monthly or quarterly cashflow compared to offering equity. The reason is that the lending crowds often seek either monthly interest and repayments on the loan or just ongoing interest returns. Because real estate crowdlending is a capital-intensive industry, it is often only interest bearing or a so called full-bullet loan with only one total payment at the end of the loan. For a crowdlending investor this means less cashflow and lower grades of diversification.
However, a very positive aspect that outweighs the low cashflow is the security of a property. Real estate is a great way to build a collateral backed portfolio with more secure assets that do not have the same price fluctuations as shares in a business or a stockpile in a warehouse might have. The assets of a real estate can rarely be compared to other assets available in the crowdlending market in terms of security, but the properties are usually carrying other types of loans and the risk can be high. This also results in high interest rates.
For a real estate developer this type of financing is often a very good solutions since the loans can be structured in a more flexible way and the time it takes to get a crowdfunded loan compared to banking loans are far superior. All this makes real estate crowdlending a good objective for online lending because the borrowers are getting important benefits for running their real estate business, while real estate crowdlenders get a return that commensurate to the risk which is limited to the security of the property.
6. Invoice Trading
Invoice trading, invoice financing, receivables financing and invoice crowdlending are all general terms used for asset-based lending products that allow companies to finance slow paying customers. This allows companies trading with governments and other payers who often require a long payment time when buying products and services.
This act of using a supplier as a credit line or “bank” is common practice since invoices are usually not interest bearing: you buy a product or service and pay the amount in for example three months. For companies, being able to sell this invoice with a discount to get the cash right away helps equalize the company’s liquidity while someone else carry the liquidity fluctuations and gets a return for the risk of the buyer not being able to pay for the product.
There are two ways for companies to finance their outstanding invoices. The first and most basic is invoices being sold for an immediate payment to directly improve the working capital of the company. The second and more complex is invoices being used as receivables to secure a revolving line of credit usually allowing companies to borrow up to 80 % of the eligible receivables. The characterization of invoice trading is that it is asset backed lending: the asset is a debt from one company to another amounting in an invoice to be paid at a certain date in the future.