In recent years, crowdfunding and crowdlending have become increasingly popular as traditional investment alternatives. Both of these forms of collaborative financing allow investors to finance projects or businesses, but there are significant differences between the two options. In particular, crowdlending, also known as lending-based crowdfunding, offers in my opinion unique advantages over traditional crowdfunding.
What is Crowdfunding?
Crowdfunding is a form of collaborative financing in which a business or individual raises money from a diverse range of investors, often through an online platform. These investors contribute small amounts of money to finance a project or business idea and in return receive a reward, such as a product or service, or an equity stake in the company. Crowdfunding is used extensively in several industries, including art, music, technology, and real estate.
What is Crowdlending?
Crowdlending, on the other hand, is a form of collaborative financing where a business or individual obtains a loan from a number of investors through an online platform. Investors provide funds in the form of loans and in return receive interest on the loaned principal. Crowdlending is often used as a form of financing for businesses, real estate projects and personal loans.
Differences between Crowdfunding and Crowdlending
As we said before, in crowdfunding, investors contribute small amounts of money in exchange for a reward or an equity stake in the company. In crowdlending, investors provide a loan to the business or individual, and in return receive interest on the loaned principal. Due to the funding structure, there are differences between the two.
- Financial return. In crowdfunding, the financial return depends on the success of the funded project or the increase in the value of the company. There is no guarantee of a financial return and investments may involve a high degree of risk. In crowdlending, investors receive interest on the loaned principal, which is usually set in advance and offers some certainty of a financial return.
- Risk and guarantees. In crowdfunding, investors are often exposed to significant risk as the success of the funded project or business may be uncertain. Furthermore, investors may not have any guarantees or protection in the event of project or business failure. In crowdlending, investors, providing a loan, have a priority interest on the principal lent if the financed business or project defaults. This means that crowdlending investors have greater protection and security than traditional crowdfunding.
- Control over the investment. In crowdfunding, investors generally have little or no control over the funded company or project. The management of the company remains in the hands of the founders or project promoters. In crowdlending, on the other hand, investors have a special purpose loan agreement with the financed company or individual. This means they have a creditor position and can have more control over the investment. For example, including the terms of the loan, the warranties and contractual clauses.
- Platform Transparency and Trustworthiness. In crowdfunding, platforms can vary greatly in terms of transparency and trustworthiness. Since investors contribute unsecured monies, it is important to select reputable platforms with a history of successful trades. In crowdlending, platforms tend to be more regulated and offer more guarantees to investors, as investments are based on loans with interest and legal contracts.
Why Crowdlending could be better than Crowdfunding
We can compare crowd funding to equity investment, while crowdlending to debt investment. Crowdlending offers some advantages that I consider essential for my investment approach.
First, it offers greater certainty of financial return, as investors receive interest on the loaned principal. In addition, crowdlending investors have greater protection and security. Since I consider these investments more risky than classic investments, I prefer to have some more guarantees, even if I lose some gains.
Risks associated with Crowdlending and possible solutions
Like any form of investment, Crowdlending also has risks that investors should consider before making a decision.
- Risk of insolvency of the financed company. The financed company or project may not be able to repay the principal and interest on the loan, causing a financial loss for investors. To mitigate this risk, it is important to carefully evaluate the creditworthiness of the business or project before investing. Crowdlending platforms often carry out a risk assessment of the company or project before accepting them on their platform. Also, it is advisable to diversify your investments into different projects to reduce the impact of a potential non-payment.
- Liquidity risk. Unlike other types of investments, crowdlending can be less liquid. As investments are usually medium to long-term and may not be easily sold or repayable if you need immediate liquidity. The advise is to carefully evaluate your investment horizon and ensure that you are willing to hold your investments until they mature.
- Risk of changes in interest rates. Interest rates may change over time, affecting the return on investments in crowdlending. An increase in interest rates could affect the return on investments, while a decrease could adversely affect reinvestment opportunities. For this reason, I suggest you to invest also different projects of different maturities to reduce the impact of any changes in interest rates.
As last suggestion, it is important to choose crowdlending platforms that are compliant with your country laws and regulations. We have to pay taxes and report our investment to our country, so make sure to control the laws.
Mentality to invest in crowdfunding/crowdlending
- Platform business model study. It is important to understand the business model of the crowdfunding or crowdlending platform in which you intend to invest. Understanding how the platform works provide you a better understanding of the associated risks. For example a platform investing actively in projects can be positive because they believe in their offers, but combine project risk with that of the platform. Carefully read the terms and conditions offered by the platform and fully understand the investment process and risk management policies.
- Investment Monitoring. Once you have made your investments, it is important to monitor them closely over time. Track investment performance, verify interest or yield payments, and watch out for any warning signs such as late payments or changes in the proposer’s financial situation. In case of problems, try to act promptly and take the necessary corrective measures.
- Prepare for losses. Despite all the precautions taken, crowdfunding/crowdlending investments always involve a certain degree of risk. It is important to be realistic and be prepared for losses. Make sure you only invest funds that you can afford to lose without compromising your personal financial situation.
Why I am considering to including them in my investment portfolio
I’m still taking the situation into consideration and studying the platforms. In any case, I think this type will not exceed 1-2% of my portfolio. In case you will see updates.
But now we can talk about the pros I’m considering.
- Portfolio Diversification. Crowdfunding or crowdlending investments can provide an opportunity to diversify your investment portfolio. Adding this asset class can allow you to expand your investment range and reduce risk concentration in a single asset class or sector.
- Access to investment opportunities that are otherwise hard to access. Crowdfunding and crowdlending often offer the opportunity to invest in projects or businesses that may be difficult to access with traditional investment methods. This can include innovative start-ups, real estate projects, social enterprises or locally owned businesses. This open up the possibility to participate in emerging sectors or markets.
- Potential for attractive returns. Investing in crowdfunding or crowdlending can offer the opportunity to earn attractive returns. Yes with also high risks, because of this I’m looking only to a small part of my portfolio.