The rise of Crowdfunding, Peer-to-Peer and Peer-to-Business platforms
In 2006, Jeff Howe coined the term crowdsourcing to describe what he saw happening increasingly around him, primarily as a result of the internet. In an ever more connected and inter-networked world, things can be achieved by people from all over the world collaborating and working together simultaneously. Crowdsourcing is essentially an ‘open call’ for contributions from a large group of people to solve a problem or develop a solution.
As Jeff put it,
“Technological advances in everything from product design software to digital video cameras are breaking down the cost barriers that once separated amateurs from professionals. Hobbyists, part-timers, and dabblers suddenly have a market for their efforts, as smart companies in industries as disparate as pharmaceuticals and television discover ways to tap the latent talent of the crowd. The labour isn’t always free, but it costs a lot less than paying traditional employees. It’s not outsourcing; it’s crowdsourcing.”
So what has crowdsourcing got to do with crowdfunding and peer to peer lending?
According to Wikipedia, arguably the most successful and certainly the most famous example of crowdsourcing, defines crowdfunding as, “the collective effort of individuals who network and pool their money, usually via the Internet, to support efforts initiated by other people or organizations.”
Crowdfunding, peer-to-peer and peer-to-business finance can be seen as a subset of the broader concept crowdsourcing – in fact almost the opposite of it. This is because they too elicit contributions from a large group of people, mostly online, to solve a problem or enable a solution. However crowdsourcing presents a problem which requires contributions from the crowd to provide the solution. Crowdfunding, peer-to-peer and peer-to-business project creators present the solution to a problem, which requires financial contributions from the crowd to enable it.
The contributions from crowdfunding, peer-to-peer and peer-to-business finance are of course monetary in nature with individuals being able to give relatively small amounts of money. Collectively taken together, this can add up to sizeable sums with which to solve problems or develop solutions.
The funds gathered from online crowds can be used to finance new products, businesses, cash flow problems, reduce poverty, build social enterprises, buy a new car, fund charities, expand and grow businesses, create new art or crafts, put on shows, conduct research, provide education, expand renewable technology, buy a new house, pay for a mortgage, pay tuition fees or even enable spicy honey badger sauce to come to market… the list goes on.
If you can think of something to spend money on, the chances are, it can be crowdfunded.
On the other hand, if you need money to spend on something and can show that you can pay it back, the odds are there are loads of online peers who can lend you the money.
Peer-to-peer and peer-to-business lending, as the names might suggest, involves many individuals (peers) lending money to individuals or businesses through an intermediary – peer-to-peer (P2P) or peer-to-business (P2B) lending platforms. Many individuals can lend relatively small amounts of money to individuals or in some cases (e.g. Funding Circle) businesses.
Likewise, crowdfunding involves many individuals donating, investing or lending to individuals, projects, organisations or businesses through an intermediary – crowdfunding platforms.
It is widely accepted throughout the world that crowdfunding can be broken down into five different models – one of which accommodates most P2P & P2B platforms very comfortably.
The five crowdfunding models are as follows – the fifth being a combination of these four:
Donation crowdfunding – individuals give small contributions towards a charitable cause without any expectation or possibility of getting your financial contribution back. This is probably the oldest form of crowdfunding. NGOs and charities have been using this method of raising funds for decades – if not longer. Many charities are now using the internet to raise funds, enabling individuals from around the world to contribute as much or as little as they like to reach a funding target. Modern day charity crowdfunding has done away with Auntie’s dodgy fundraising thermometer and taken to the digital world of online crowdfunding.
Reward crowdfunding – this type of crowdfunding is what has really made much of the headlines in recent years, championed by Kickstarter and Indiegogo. Basically individuals give relatively small amounts of money to projects, individuals, causes, ventures or businesses. In return, these people expect to get some kind of reward – often reflecting the amount that you give. Give more. Get better stuff. This kind of crowdfunding is the most popular and probably the most fun. The more imaginative the rewards, the more enticing it is for people to part with their pennies and pounds. Some examples of the kind of thing to expect is a ticket to see the band, a CD, your name engraved on a plaque, a free product, the chance to choose the design or colour of the product or even ‘pop in for a pat’ and a free coffee in your local East London cat café courtesy of Indiegogo.
Equity crowdfunding – this type of crowdfunding enables savvy investors the chance to invest in startups, newly established or established businesses. In return for financial contributions, again relatively small, individuals can have an equity stake – entitling them to a share of revenues or profits. This form of crowdfunding is probably the newest type but also the fastest growing. Crowdcube, the world’s biggest equity crowdfunding site, grew over 500% over the past year! It is quickly attracting the attention of celebrities as well as mainstream financial professionals.
You always have to remember that investing your money like this carries significant risks – especially within startups. Most people know the majority of start ups fail in the first two years. While it is not sensible to put all your life savings or pensions into one of these start-up businesses, they do have the potential for great returns and a chance to diversify your investment portfolio. This kind of crowdfunding is of greatest concern to the regulators and rightly so – care must be taken and the risks must be made loud and clear by the equity crowdfunding platforms such as Seedrs and Crowdcube.
Lending/Debt/P2P/P2B crowdfunding – this type of crowdfunding enables individuals to invest their money in businesses, projects or individuals with the expectation that they get their money back as well as some interest on top of this. In 2006, MyC4 enabled individuals to lend to poor people with microfinance loans while choosing the level of interest. Kiva also offers this service however investors only get their money back with no interest. (It is the microfinance institutions that take the interest instead which is on average 15-25%.) Funding Circle has adopted a different model enabling individuals to lend to established businesses with an average of 5.8% interest – which is much better than what you see from the high street banks these days. Abundance Generation enables individuals to put their money into long term loans called debentures to finance renewable energy projects while Thrill Capital provides loans to future sports stars who then repay their loan with interest from their future salaries.
The key, if not only difference, is that these platforms aggregate the funds from many individuals’ relatively small financial contributions and then allocate the funds to individuals or businesses seeking loans. Zopa however is planning to soon enable individuals to choose the individuals they lend their money to, making it very similar to Funding Circle’s P2B crowdfunding model – however this will be P2P crowdfunding i.e. individuals lending directly to individuals. At the moment, Zopa and Rate Setter do not allow individuals to choose the individuals they lend to. This is really the key defining characteristic of P2P lending as opposed to P2P crowdfunding.
Some other key defining characteristics of P2P and P2B finance is that it is conducted for profit in the same way equity and lending crowdfunding models are. Furthermore, it is not necessary that lenders and borrowers have a previous bond or prior relations just as with other crowdfunding models. Transactions tend to take place online and some P2P and P2B platforms allow lenders to choose the businesses or individuals that they invest in as with crowdfunding models. Finally loans from P2P lenders can in some instances be sold to other lenders – this is sometimes referred to as a liquidity or secondary market. This area is quickly developing both for equity and lending based crowdfunding as well as P2P and P2B platforms.
Most P2P and P2B intermediaries provide the following services:
on-line investment platform to enable borrowers to attract lenders and investors to identify and purchase loans that meet their investment criteria
development of credit models for loan approvals and pricing
verifying borrower identity, bank account, employment and income
performing borrower credit checks and filtering out the unqualified
processing payments from borrowers and forwarding those payments to the lenders who invested in the loan
servicing loans, providing customer service to borrowers and attempting to collect payments from borrowers who are delinquent or in default
legal compliance and reporting
finding new lenders and borrowers (marketing)
P2P, P2B and crowdfunding are playing an increasingly important roles in providing financial services to projects, individuals, businesses and causes which are unable to get funding from mainstream financial services.
Like banks, these platforms provide financial intermediation services to businesses and individuals; however, they do it in a different way. They rely on the internet to connect businesses, organisations, groups and individuals with many individuals contributing relatively small sums.
Lending and equity-based crowdfunding platforms including P2P and P2B have become attractive alternatives for individuals, projects, organisations, start ups and small businesses who would find very difficult to get a bank loan. These platforms can serve this market with a different approach to risk management.
In lending and equity based models the risk of financing a project is not assumed by a single depository institution – the bank (and its clients), but by investors who willingly decide which projects to finance based on their tolerance to risk and other considerations such as community involvement, geography, industries or environmental concerns. The risk is broken down into small pieces and crowdfunding and P2P/P2B platforms sell them to a potentially large group of investors. In other words, risk is passed from the bank to the “crowd”, where it is diluted.
For the first time in history, businesses and individuals have access to an unprecedented source of capital created from the small contributions of millions of individuals around the world. This is good news for individuals and entrepreneurs, who may never have to worry about not being able to access traditional lending sources or using more expensive funding solutions to finance their projects. For banks, this poses a challenge. From here on, they will face a new competitor with lower operating costs, a different approach to risk management and a simpler product offering.
Regardless of semantics, P2P, P2B and crowdfunding platforms are providing alternative ways to access funds from the masses who are proving to be willing to provide their hard earned cash. It is true that the underlying motivations of these people vary massively. Some are profit orientated while others are geared towards solving social problems or improving society or the environment. Either way, the choice and opportunities are available in increasingly abundant and diverse forms. The opportunities this fast growing sector is offering is very exciting. The journey is far from over. It is really only just beginning.
By Kieran Garvey