How Does Crowdfunding Differ to P2P Lending?

Crowdfunding and peer-to-peer lending are often regarded as one and the same, and it’s easy to see why: they both involve people coming together to provide financial support for something.

In reality, however, they are very different beasts.

What is crowdfunding?

One of the reasons why people confuse crowdfunding with peer-to-peer lending is that the word ‘crowdfunding’ is often used as a catch-all term for many different financial activities.

For the purposes of this article, we’ll be using crowdfunding to refer to two specific types of finance: equity crowdfunding and reward-based crowdfunding.

We’ll then take a look at how these two compare to peer-to-peer lending.

Reward-based crowdfunding

You’ve probably heard of reward-based crowdfunding on websites like Kickstarter, where someone with a project, such as launching a niche recipe book, looks for like-minded individuals who can help with raising funds for that project (for example, to cover the printing costs).

In return for raising money, they’ll usually get some form of reward: in this case, it might be a signed copy of the book or an acknowledgement in the introduction.

The crucial point here is that it’s not an investment in the conventional sense: an investor on a crowdfunding site is funding a project, but not expecting a financial return. They’ll be rooting for the project to succeed, but they don’t stand to gain or lose money either way.

Equity crowdfunding

Equity crowdfunding is closer to an investment in shares – also known as equities, hence the name.

Equity means owning a part of a company. When you have equity, it’s like having a piece of the business. If the company does well and makes money, the value of your piece can grow, and you might earn money from it. If the company doesn’t do well, your piece could lose value. So, equity is basically a share in the company that can go up or down in worth, depending on how the company performs.

Typically, people with either a young business or maybe even just an idea, are raising capital to grow that business. The people and institutions who fund businesses through equity crowdfunding get a stake in the business: it might fail, in which case the investor could lose their investment, or it might prosper, in which case the investor could be in line for a tidy return.

From the point of view of the business seeking funds, there’s a clear advantage to this model: if the business does fail, its shares are simply worth nothing, and the business owners would not need to repay anything.

Not so good for the investors, but then they have the prospect of substantial returns if the business makes a profit.

What are the risks of crowdfunding?

For investors, the primary risk of equity crowdfunding is that the business they’ve backed may fail, in which case it’s likely that they’ll lose all of their investment.

There are other things to bear in mind too – while it’s relatively easy to sell a share in a listed company such as Apple, shares in smaller, early-stage companies are notoriously illiquid and subject to volatility. This means investors might find it difficult to access their money after it’s been invested.

What is the peer-to-peer lending system?

Peer-to-peer lending is a different model: rather than owning a stake in a business, investors’ money is matched, via an online platform, to a loan for a person or business.

A loan is very different to equity: it’s a specific amount of money, repaid over a defined term, and investors earn a return via interest payable on the loan.

Peer-to-peer lending platforms may specialise in lending to certain types of borrowers – individuals, businesses or property businesses – or may diversify across borrower types.

What are the problems with peer-to-peer lending?

The main risk when lending money is that the borrower doesn’t pay it back.

To help investors deal with this risk, some P2P platforms offer features such as a Provision Fund, which takes contributions from borrowers as part of their loan, and steps in case of a missed payment.

However, the bottom line is that this is still an investment, and peer-to-peer lenders cannot guarantee that investors’ money will always be safe.

Crowdfunding vs P2P lending

Comparing the two models, equity crowdfunding is higher risk, but it could be argued that the rewards on offer reflect this.

As a result, equity crowdfunding platforms tend to be aimed at sophisticated investors, i.e. people with a very high level of financial knowledge, as well as a good understanding of early-stage businesses and the risks involved.

Peer-to-peer lending provides more predictable returns, and both the risks and returns are comparatively lower.

About the author

Paul Marston was head of commercial divisions at RateSetter, a peer-to-peer lending platform that matched investors with creditworthy businesses and consumers throughout the UK. Marston has a wealth of experience within SME finance, having previously held senior positions at RBS and Secure Trust Bank.

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Your common questions answered

Is peer-to-peer lending illegal?

No, peer-to-peer lending is not illegal.

In fact, it’s a well-established form of finance that is regulated by the Financial Conduct Authority (FCA) in the UK.

This regulation ensures that P2P lending platforms operate in a transparent and fair manner, providing protections for both borrowers and investors.

Is peer-to-peer lending worth it?

Whether peer-to-peer lending is worth it depends on your financial goals and risk appetite.

• For investors, it offers a way to earn returns that are typically higher than traditional savings accounts, though with some level of risk.

• For borrowers, it can provide access to finance that might be more flexible or available than through conventional banking routes.

As with any financial decision, it’s important to carefully consider the risks and rewards.

Is peer-to-peer lending legal in the UK?

Yes, peer-to-peer lending is entirely legal in the UK.

It operates under strict regulations set by the FCA, which helps ensure that both borrowers and investors are treated fairly and transparently.

These regulations are designed to protect consumers and maintain the integrity of the financial system.

Can you lose money in P2P lending?

Yes, there is a risk to investors of losing money in peer-to-peer lending.

While many P2P lending platforms have measures in place to mitigate these risks, such as Provision Funds or diversified loan portfolios, there is no guarantee that all loans will be repaid.

Investors need to understand that, like all investments, peer-to-peer lending carries risk and it’s possible to lose some or all of the invested capital.

How to borrow money from peer-to-peer

To borrow money from a P2P lending platform, you’ll typically need to start by creating an account on the platform and completing an application.

The platform will assess your creditworthiness and determine the loan terms, including the interest rate and repayment schedule.

If approved, your loan request will be listed on the platform and matched with investors who are willing to provide the funds.

What happens if you don't pay back a peer-to-peer loan?

If you fail to repay a peer-to-peer loan, it can have serious consequences.

The P2P platform may take steps to recover the outstanding debt, which could include additional fees and charges. Your credit score is also likely to be negatively impacted, making it more difficult to obtain credit in the future.

In some cases, the platform may pursue legal action to recover the funds.

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