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 structured can have a massive impact on your risk as an investor. In peer-to-peer (P2P) 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.

At the same time, investing in P2P loans can involve either three or four parties. Peer-to-peer platforms using a direct investment structure will only have to involve a borrower, an investor and the P2P lending platform. However, some peer-to-peer platforms are using loan originators to help them acquire borrowers to the platform, which adds an extra party in the loan process. In this case, the P2P lending platform can choose to let the loan originators structure the investment as either direct or indirect. This results in critical differences in what happens if a borrower defaults that you need to be aware of if you are looking to or already investing in P2P loans. If interested, you can find a list of buyback guarantees and provision funds in P2P lending here.

Why Investment Structure in P2P Lending is 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 bankruptcy occurs on the loan originator, like for example the use of a buyback guarantee.

What this means is that being aware of the investment structure is being aware of what will happen if the borrower defaults or the 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. However, 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 Investments - Key Takeaways

  • 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 four-party platforms (but not all) that are structured with both a platform and a loan originator to facilitate the lending – e.g. Mintos, IUVO Group, and Grupeer.
  • The indirect investments structure in P2P lending lets you invest in the loan originator through the platform.
  • Indirect investments are investments where the money is pooled together in a vehicle which itself owns one or more 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 - Key Takeaways

  • Refers to the usual way of using crowdfunding to invest in equity or loans with only the P2P 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 lets you invest through the platform.
  • Direct investments are investments where 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.