I have been thinking a lot about how the legislation of P2P lending was. While i know there is a risk when investing, i want to figure out how to be sure that i am not a part of a pyramid scheme and avoid scams. Therefore, i have done some research to learn the rough edges of P2P lending legislation within Europe. The one thing i fear the most with things that is to good to be true is scams.
There are three types of P2P lending. The types are; equity crowdfunding, rewards-based crowdfunding and peer-to-peer lending. Each are covered by the same legislation and the major finding is owners and managers at the crowdfunding platform has no criminal records. Furthermore, they have to provide the investors with the information covering the asset safekeeping. Crowdfunding providers are obligated to protect both the investors and the businesses. Hence, thorough due diligence has to be conducted. Lastly, the management has to have explicit knowledge, skills and experience in order to manage the crowdfunding service.
Keep in mind that the current legislation is basically the anti-money-laundering policies and accompanying transfer of funds. The European Commission has only done a proposal, which is what i have went through in the post.
The Three Types of P2P lending
There are three types of P2P lending according to the European Commission. The three categories are; Equity crowdfunding, rewards-based crowdfunding and Peer-to-peer lending.
The equity crowdfunding method consists of selling a stake of your business to a number of investors. The return is the equity from the investors. Equity funding is a established methods, e,g, with private equity, venture capital and angel investing. The main difference with crowdfunding and the other traditional types is that crowdfunding offers investment to hundreds or even thousands of investors. Whereas traditionally it would be 1-on-1 investments.
Think of shark tank. The investors in the judging chairs make an offer for a percentage of presenters business, in return of equity to the presenter. Instead the presenter now offers hundreds of people the option to invest with their business. The rights of the investors can vary, but often shareholder have voting rights. Therefore, equity seekers has to think thoroughly to which extend investors has control.
Rewards-based crowdfunding is when an investor donates equity to a business or project with the expectation to later get a non-financial reward in return. The rewards can very from goods to services. Equity invested by the investor does not have to be repaid with this type of crowdfunding. The equity seeker has to provide the promised service of good, instead of financial repayment.
This is a very common type of equity funding for startups and entrepreneurs as it allows a way to fund business’ or products.
The best example is kickstarter.com
The peer-to-peer lending is a direct alternative to bank lending with the main difference being loan originates from many sources rather than one. The due diligence of the loans/borrowers are carried out by the platforms. The platforms have a duty to protect both businesses and investors. Furthermore, platforms normally require financial accounts and trading track records.
There is a higher flexibility with P2P Lending as you can apply for loans at lending platforms if the bank refused. Furthermore, just like the legislation of the banks, you are required to repay the loans when borrowing. This is a huge upside for the investors, as the platforms can take legal action. The loan amounts vary greatly, and typically the platforms offers a very low starting capital to invest.
Business’ Need P2P Lending
Normally when business’ has to expand/grow they have to seek capital one way or another. Generally, smaller business’ can use their retained earnings, however, if the business needs more money than what there is on their bottom line, they have to seek external capital.
This means that the business would have to find a bank whiling to issue a loan to the business. Another method is to find investors. Typically small business’ seeks business angels or grants, depending on the size of the company. Where a business angel could potentially bring their expert knowledge to make the business grow. If the business is in the starting phase, they can apply for grants for expert consulting.
If the business is of bigger size they can go for venture capitalists, or even try entering the stock market with initial public offerings (IPO).
So why is the P2P Lending Needed again?
The short answer is, the gap between the retained earnings and bank loans are to big. This problem has been picked up by the European Commission. The European Commission has gaped the problem by implementing legislation for business’ to have better and more competitive options.
Personally i am investing on different P2P lending platforms. I do this as i want to generate cash-flows. Furthermore, P2P lending are generating some incredible returns. You can follow my personal monthly income from P2P lending platforms here. Furthermore, you can sign up at Envestio and get an additional 0,5% on all of your investments in 270 days, when you deposit more than 100 EUR.
Valdis Dombrovskis – Vice-President in charge of Financial Stability, Financial Services and Capital Markets Union has made the following statement:
“To compete globally, Europe’s innovators need access to capital, space to
innovate and scale to grow. This is the premise for our FinTech Action Plan.
An EU crowdfunding label would help crowdfunding platforms scale up and
match investors and companies from all over the EU, giving more choice to
investors, and more opportunities for firms and entrepreneurs to pitch their
innovative business ideas to an EU-wide audience of potential investors.”
He states that crowd-lending/crowdfunding/peer-to-peer lending is required to better make business’ grow. Furthermore, with a legislation in place business’ can pitch to an EU wide audience. Which also means that investors from all over EU can help business’ acquire the capital which they need.
Why P2P Lending is good for investors
If you want to own real estate you will probably have to make a down payment of 20.000 EUR, and expect a return of 8-10% annually. With P2P lending, investors can now get the same cash-flowing investment, however, with opportunity to get returns over 20%.
In many ways the way you invest in P2P loans is much alike stocks. You have a platform where stocks or loans are issued, then you have the borrower/company, and the investor who then invest in the loans/stocks. The main difference is that stocks are much more complicated to follow. Furthermore, stocks can cost hundreds of EUR per stock.
This makes it difficult for a typical investor to diversify. Even more so, it makes people stay away from investing in stocks. The alternative investment here could be P2P lending, where you can invest for as little as 10 EUR on most platforms. Platforms such as Fastinvest even lets investors invest for only 1 EUR per loan. This also makes the P2P lending accessible for a lot more people (potential investors) than the stock market.
With stocks you have to analyse a lot of different things, such as: management, subsidiaries, fundamental analysis, technical analysis, the product(s) they produce/sell, their innovativeness and so on.
With crowd-sourcing/crowdfunding/P2P Lending you would have to do similar analysis. However, the platforms typically have buyback guarantees, and loans are thoroughly picked to be on the platforms. You typically get the same information as with stocks or real estate, like loan to value ratios, whether it is personal loans or business loans. On platforms such as Envestio, you get a complete overview of the projects you can invest with. This means you can evaluate the risks before investing. E.g. you have the opportunity to look up the borrowing company, and look into financials, track records, solvency ratio (among other financial ratios) and much more. Hence, it is similar to investing in stocks.
European legislation of P2P lending
The most important things related to P2P lending for investors is whether or not you money is safe.
In the document from the European Commission HERE, you can find in article 9 that the lending platform has to inform you on the terms and conditions they provide asset safekeeping. Furthermore, whether they are using third-party providers for asset safekeeping and if they are applicable to any national laws.
For you as an investor, it means that you can base your own risk analysis on the third-party asset provider, or the platform itself. If the platform is very new, with limited investment loans, it might be a warning signal if they do not have a third-party provider. Hence, the third-party provider have the expertise of safekeeping assets, and the platform should have a focus on the loan development.
The due diligence
Authorization to be a crowd-lending service provider requires the applicant to be a legal person, applying to the ESMA (European Security and Markets Authority). One of the elements which the applicant has to comply with is to proof that they have a good reputation and posses appropriate knowledge and expertise to manage the prospective crowdfunding service.
Furthermore, the applicant has to prove they have no convictions or penalties in accordance with national rules. This includes money laundering, fraud, insolvency law, financial services legislation and more.
Management has to have explicit knowledge, skills and experience in order to manage the crowdfunding service. The management is required to put in the time to perform their duties.
P2P lending platforms carries out the due diligence on every loan provided by the platform. Regulated by law, platforms has to protect both investors and businesses. Furthermore, as a borrower you are legally, like with bank loans, required to repay the loan.
The conclusion is that there is now some obvious signals which can be investigated. When signing up to different platforms, it is possible to read the terms and conditions to gain insight. It is now clear that there are multiple things which the platforms has to comply to. The post does not cover the full legislative report here. The main elements of the P2P lending legislation have been addressed to reach a rough understanding of the rule-set.
I do not find the P2P lending troubling with the current legislation. However, platforms has to comply with the P2P lending legislation, which to my knowledge all do.