Finding a funding family

When online platforms first enabled individual investors to pledge money towards small businesses, a new type of fintech was born. A few years later, many retail investors saw their peer-to-peer options slowly vanish. Here is a look at the risk and reward of P2P, and what happened to the platforms that created it


Netflix. Apple. Amazon. How many everyday investors have wondered what the next big thing will be, followed by a thought that says ‘if I’d picked one of those stellar companies to invest in back when they were tiny, I’d be sitting on a gold mine.’ Plenty of companies come and go without ever making the headlines, but still, it’s fun to imagine investing in a start-up that later goes global. Crowdfunding was an early fintech trend that aimed to open up some of this investment potential to regular people, not just so-called angel investors, and over the last 10 to 15 years, there have been almost as many crowdfunding platforms as there are products and businesses to fill them (see Fig 1). Peer-to-peer lending also emerged during this period, as a model that doesn’t have stock-market exposure, but which still offers the potential of some returns to investors while giving SMEs access to finance they need to grow, cutting out the idea of needing angel or institutional investment and ideally expediting growth for start-ups.

For those who are interested in investing in start-up businesses but don’t have the clout of angel investors, these platforms might seem to provide an opportunity to invest or loan money in exchange for a market-beating rate of return. For ordinary savers, current interest rates via traditional banks are not difficult to beat, but the risk is still much higher and so whether this is a viable – let alone sensible – investment strategy when compared to, say, broad-based index trackers, may not be as certain. After the massive business disruption from Covid, successive stock market crashes, and a difficult environment for small and medium enterprises, how does crowdfunding or P2P lending and investment look and feel now? To individual customers and investors, and the people looking to put their product or service on a platform, does it stand up to a broader, objective business analysis?

For retail (individual) investors, there are myriad platforms that enable you to pick a company you like the look of and pledge some money towards it. That said, investment diversification is the wise choice in order to protect yourself from putting all your eggs in one basket, so one immediate difficulty with traditional crowdfunding is that unless you are going to diversify across hundreds of investments with small amounts, you likely won’t see a return. With small companies or kickstarters, people tend to invest because they might like the idea of the business, but realistically the likelihood of any such company becoming the next big thing is slim. Consider venture capital firms that invest in early stage businesses but do so through a fund – in this way they make hundreds of investments to spread the risk, and hope that one of them will pay off the entirety of the fund.

Sowing the seeds of potential
The good news is that it is still possible to invest money in a range of start-ups in exchange for equity, through a diversified fund. The platform Seedrs was launched in 2012 and at the time was the only crowdfunding platform to be authorised by the UK’s Financial Conduct Authority. In 2017 it had its own unicorn success story with the digital challenger bank Revolut raising £4m via Seedrs.

Lending platforms emerged several years ago to connect small businesses to small lenders with the aim of growth for both. The platforms are part of the burgeoning fintech industry, providing the technology, the platforms, the connections, and the marketing to enable their lending model.

The 36H group was founded from the first five such platforms to be approved by the UK’s Financial Conduct Authority, meaning they are themselves regulated and one of their aims was in turn to campaign for more regulation in the emerging sector. Coming together they became a voice for the fledgling industry and engaged directly with government around regulation and strengthened the voice of the industry within the fintech and financial sectors themselves.

During the pandemic, the UK government rushed to create a financial support structure for businesses that were impacted by successive lockdowns at home and abroad. The Coronavirus Business Interruption Loan Scheme, and later bounce back loans, were created to address this need. The 36H group argued on behalf of its industry that fintech lenders were approved more slowly than the traditional bigger banks in being granted the ability to facilitate these supports, but eventually approval was given.

With P2P lending known to some as the wild west of the financial industry, regulation was no doubt needed, but tighter legislation, combined with the global shake-up to business and industries provided by the pandemic, means not many of the original 36H group are still standing in quite the same way.

Funding Circle
One of the ‘Big Three’ lending platforms, Funding Circle was founded in 2010 and offered retail investment for the following 10 years, but stopped in 2023 after already having enacted a two-year pause on this service during the pandemic. The platform underwent a process to return investors’ money as their loans matured but the reality of this didn’t go down well with all investors, who were made to wait for their money to be paid back piecemeal before it could be transferred to another platform and thus protect its ISA status.

Press releases from the time advised that Funding Circle was focused on government-backed schemes during the pandemic, and indeed they were the first such platform to access and be involved with the government’s various bounce back loans and small business supports from that time. Eventually the decision was made not to return to using retail investors to fund their business clients at all, and the P2P arm of the businesses was permanently closed.

Another of the Big Three P2P lending platforms was RateSetter, which ran almost exclusively on its retail investment model and was a pioneer in this field. A press release from 2019 hailed the incoming tighter regulations in the P2P sector that year, claiming these would “raise standards in risk management, governance, disclosure, marketing and wind-down planning – decisively addressing any sense that P2P is lightly regulated.”

Rhydian Lewis, RateSetter CEO, said: “We will look back on this as a watershed moment for our industry – the moment that peer-to peer investing came of age as an asset class, competing against other mainstream investment options and the banks as an attractive way to put money to work.” But ironically, RateSetter essentially became one of the big boy banks they originally sought to take on. The aim of the new regulations was to reduce the P2P lending sector’s ‘wild west’ reputation, but in 2020, RateSetter announced its takeover by Metro Bank and advised that they too would stop crowdfunding loans, with all money for future loans coming from their new parent company.

Closing out the original Big Three, Zopa was in fact the first ever P2P lending platform in the UK but it, too, succumbed to the twin pressures of increased regulation and what the CEO Jaidev Janardana cited as negative investor sentiment towards P2P which made continuation of the retail investment arm of the business impossible. Zopa became a bank itself in 2018, but during the pandemic the firm decided that costs were too high to give satisfactory returns to retail investors and meet their obligations to borrowers. The difference is that Zopa, being a bank, bought back the investments of approximately 60,000 RI customers at face value, so anyone with an ISA through them didn’t have to wait for loans to mature or any other wind down before they could take their ISA elsewhere.

Lending Works
In 2021, another consumer lending platform, Lending Works, closed its P2P structure after eight years in the sector. Founded in 2014 and backed by angel investors, the platform was developed to provide personal loans. Fast forward to 2023 and the company is now known as Fluro, and backed by institutional funding lines. Today, not only does it offer personal loans backed by fintech and data to offer the now-standard features of decisions in minutes, pre-approval, and flexible payback schemes, it also has an industry offering of lending-as-a-service, powering UK businesses and household names like Direct Line and GoCompare.

Diversification and moving away from crowdfunding its loans has enabled Lending Works to ride out the storm of Covid and develop new and exciting offerings in the fintech sector. However, it too decided to pay back its P2P loans using a gradual runoff model until all its lenders were repaid.

Another firm founded in 2014 was CrowdProperty, and it’s still thriving today, having stuck to its original model and come out the other side of the pandemic. It was originally founded to tackle two problems: that of SME property businesses struggling to access the finance they needed, and that of investors being offered inferior rates for years since the financial crash of 2008. But the platform undoubtedly also benefited from the trend towards, not away from, property that took place in the pandemic.

While other sectors such as leisure, travel, and lifestyle businesses took a hammering, housing prices shot up and demand way outstripped supply. The firm states that one of its aims is to tackle the housing shortfall in the UK, and even with millions of pounds invested via CrowdProperty and elsewhere, the housing crisis shows no signs of easing and so demand will surely soar for some time yet.

Weathering the Covid storm
Four out of the five biggest lending platforms have now scaled back what they are doing or removed their retail investment offering altogether. The coronavirus pandemic can be blamed for many thousands of businesses going under, and it’s ironic in a way that some of the platforms ended up turning into the big banking models that they were originally founded to challenge.

There are two upsides for SMEs: not only do they have more choice in the fintech sector and options other than traditional institutional lending, but with that new size and power comes lending clout and greater stability for their businesses. But the platforms have largely turned away from retail investors.

Looking back to 2020, one of the first things that 36H group did was to win approval to be involved in the government-backed loan scheme for small business Covid recovery. On the surface this achievement sounds wonderful and as though it would be well within the scope of what these platforms were intended to do; namely, help SMEs. But perhaps it turned out that the other aspect of Covid, combined with the relative ease of institutional lending by comparison, was enough to force the platforms to rethink their crowdfunding model.

Most online brokers now have funds for unicorn businesses and start-ups

Indeed, who could forget the overall stock market crash that happened in early 2020, reflecting how investors the world over became more hesitant; no doubt retail investors also had doubts about putting more money into crowdfunding, and many more financially secure people were instead turning to more traditional savings, or even splurges.

This meant the P2P platforms suddenly experienced less interest, and income, from their retail investors and so to fulfil their commitment to SMEs, they had to fund loans through more traditional institutional means.
As for the retail investors themselves, many of them will have moved on to other investment vehicles. CrowdProperty, however, is still going strong. Maybe it’s because it is a little more niche, offering investment only within the property sector, rather than for all SMEs or individuals.

Certainly through coronavirus, its sector was lucky to be boosted rather than stymied. But that is not the only factor at play within the much wider and more complex environment of property and finance in the UK, and – lack of – traditional access to either. By sticking within its niche market, CrowdProperty’s magic formula seems to be that it essentially enables anybody with a few hundred pounds spare to be a property investor. It empowers someone who is interested in property as an investment vehicle to access this and gain comparatively stable, but not guaranteed, returns. It doesn’t offer exposure to the open stock market, and it removes the hassle and expense of taking on a buy-to-let property or other significant financial and energetic burden.

Lending platforms emerged several years ago to connect small businesses to small lenders

Property as an investment class is still incredibly attractive in the UK and abroad, and a quick look at the media flags up many reasons for this, from good old supply and demand to new and exciting property stars on social media influencing ever younger generations.

CrowdProperty allows ordinary people to invest across an entire property portfolio without buying anything directly, and crucially, allowing wide diversification within the ISA wrapper. There is the option to invest large amounts of money into any one project, but equally it has an auto invest function that acts as a protector to over-exposure and diversifies your money across every project that gets approved, if you so wish. Over the past years the platform has also offered rates of return significantly higher than banks and building societies, even now that these traditional institutions have started increasing their own interest rates post-Covid. No wonder this remains an attractive option for many.

Investing in property on the open stock market is of course also an option, and there are index tracker funds dedicated solely to real estate investment trusts (REITs) and the property sector at large across markets worldwide. Indeed, within the UK ISA or the tax-free wrapper in other countries – such as the Roth in the US – you can access funds that are purely or largely focused on property, from development of housing estates to the construction materials used to build them. But it’s not just residential property. Many REITs cover any element of property you can think of; some specialise in storage facilities, some in logistics, others in specific markets like healthcare, real estate or office buildings.

So, someone who wants exposure to property as an asset class has good options for diversification that do carry risk. This is a different approach because you are still investing on the open market, and the usual warning applies – that you can get back less than you put in. CrowdProperty also carries risk, and every page of its website carries the warning to not invest unless you understand this, but the risk is slightly different as it is limited to borrowers who may default on their obligations.

The platform has a rigorous due diligence process in place and several non-negotiable backups to protect RI lenders against this risk, including ‘first charge security,’ which essentially gives CrowdProperty the same rights as a mortgage lender to take back a property if a borrower defaults on their repayments for any reason. The platform seems to have cracked the code by keeping things simple, getting regulated, mitigating the risks, and marketing themselves as a niche investment vehicle for one thing only. It, too, began as a fintech start-up, and continues to raise funding through traditional and non-traditional means. Where did CrowdProperty turn to when it wanted to fundraise in order to expand its businesses in the first half of 2023? Seedrs.

Where the smart money is
Turning back to the possibility of picking the next unicorn through a P2P platform, bear in mind the argument that businesses that choose the crowdfunding route sometimes do so either because they are not confident in getting backing from large investors, or, worse, they have tried and failed to do so. This may be the case with boutique or local businesses that are product-based and don’t have a clearly mapped exit strategy for those who want to put their money in, grow the company, and take it out again. In the US, local bars and hospitality businesses are increasingly trying the crowdfunding model to get their business off the ground in exchange for beer tokens, merchandise, or another type of reward, but not a share in the business itself. This increases engagement but does not represent a true investment. It’s therefore important to understand the difference between the small likelihood of identifying a start-up business with lots of growth potential through a crowdfunding platform and approaching P2P as an investment strategy forming part of a wider diversified portfolio.

Those who want to invest in small and emerging businesses can still do so, but ‘safer’ vehicles exist to do this. Most online brokers now have funds for unicorn businesses and start-ups that make the grade, and it’s possible to invest in these. The old advice stands though, of placing the lion’s share of your investment money into broad based index trackers of stable markets like the FTSE 100, and if you want to invest in something rare like unicorn businesses, to max this out at maybe one percent of your overall investment capital to minimise risk.

With small companies or kickstarters, people tend to invest because they might like the idea of the business

Despite being more accessible than ever before, most crowdfunding in individual start-ups might still be better aimed at sophisticated investors who know how to value a business, understanding the risks and that they might lose the money they invest. We have all heard horror stories of people putting their life savings into things like crypto and whatever new thing we are told is guaranteed to go stratospheric, but although it’s exciting to imagine this, slow and steady still wins the day for average retail investors looking to maximise their savings or pensions. It’s natural to look back and wish you’d invested in companies like Uber or Tesla when they were in their infancy, but for every unicorn success story, there are hundreds more that die a death before getting anywhere near that stage. Better to be realistic, and if you’re going to invest in start-up businesses, ensure you diversify your portfolio and understand the investment.

The original premise of both crowdfunding and P2P lending was to make these opportunities available for a new generation of money-savvy investors who had the means to invest, but not the enormous wealth to tolerate the risks. This premise has arguably succeeded, but education and execution remain key.