P2P Lending: Indirect vs. Direct Investment Structure

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The importance of investment structure in peer-to-peer lending is often overlooked, but how the loans you are investing in are structure can have a massive impact on your risk as an investor. In peer-to-peer lending, platforms can be based on two different types of investment structure: A direct investment structure or/and an indirect investment structure.

A direct investment structure means you are buying a claim against the borrower directly. An indirect investment structure means you obtain exposure to a loan by investing in a loan issued by a platform company to the loan originator.

Peer-to-Peer lending platforms can be structured with three parties (borrower, investor and P2P platform) or four parties (borrower, investor, P2P platform and loan originator). P2P platforms without a loan originator will almost always have a direct investment structure. However, P2P platforms using loan originators can choose to let the loan originators structure the investment as either direct or indirect resulting in critical differences in what happens if a borrower defaults.

Why is Investment Structure in P2P Lending important?

You especially need to pay attention to the investment structure when investing on platforms using loan originators as this leaves the door open for more creative ways of structuring the liability if a bankruptcy occurs on the loan originator. Examples of thus could be buyback guarantee and the use of an indirect investment structure.

What this means is that being aware of the investment structure is being aware of what will happen if the borrower or loan originator goes bankrupt. This is particularly important with platforms offering buyback guarantees as a buyback guarantee can create an illusion of a risk-free environment, but there will be no guarantee if the loan originator goes bankrupt. Furthermore, it could create an incentive for loan originators to increase leverage indirectly, by originating more and more liabilities/indirect debt that needs to be paid back in the future and thereby increase the risk over time.

Who are you Really Lending Money to?

By knowing and understanding how the investment is structured, you will be able to answer the question about who you are really lending money to when investing on a p2p lending platform – both legally and in terms of who has the claim against the borrower. Are you lending to the different borrowers directly through a loan originator and a platform, or are you actually lending your money to the loan originator through a platform? Notice the difference in lending money through both the loan originator and the platform (direct investment structure) and lending money to the loan originator through the platform (indirect investment structure).

Indirect Investment

  • Refers to a way of investing in assets, but without investing in the exact asset. Instead you invest in a paper or contract saying you own a specific asset.
  • Examples of indirect investment platforms in p2p lending: Some (but not all) four-party platforms that are structured with both a platform and a loan originator to facilitate the lending – e.g. Mintos, IUVO Group, Grupeer.
  • The indirect investments structure in p2p lending let you invest in the loan originator through the platform.
  • Indirect investments are those in which the money is pooled together in a vehicle which itself owns an assets.
  • Indirect investors invest in the expertise of the people controlling the vehicle.
  • Examples of indirect investments outside of crowdfunding: Pension funds, mutual funds/unit trusts and REIT (Real Estate Investment Trusts).

Direct Investment

  • Refers to the usual way of using crowdfunding to invest in equity or loans with only the platform as a middleman between lender and borrower.
  • Examples of direct investment platforms in p2p lending: Most three-party platforms that are structured with only the platform to facilitate the lending – e.g. Estateguru, Flender and ReInvest24.
  • The direct investment structure in p2p lending let you invest through the platform.
  • Direct investments are those in which the investor owns the particular part of the loan himself.
  • Direct investors invest in the asset itself without any further liabilities or legal contracts saying otherwise.
  • Example of direct investments outside of crowdfunding: Buying an apartment and acting as a landlord, hiring a property manager, collecting the rent and expecting all the gains and losses when the apartment is sold. This is a direct investment because you own the asset and carry every risk associated with the asset.
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