In this article, we explain how to choose a crowdlending platform to make investments in business loans easier and safer.
What investments crowdlending platforms are offering?
Crowdlending platforms, operate based on crowdfunding principles, meaning they offer retail investors to invest in different companies by providing loans to them. The idea is that a big crowd of people are providing small amounts thus allowing them to raise significant funds.
Typically loans are provided to small and medium businesses that for some reason decided not to take loans from banks and are looking for alternative funding sources. Here we should be clear, that mostly it happens due to a higher risk of borrowers, that banks are not willing to take, but given that Banks are very bureaucratic organizations there might be plenty of different reasons for that.
Given that such projects are often associated with higher risk, for such investments you receive (should) a higher reward in the form of interest that could be above 10% per annum.
What is the role of the Crowdlending platform?
It is very important to understand the role of the crowdfunding platforms. The platform acts as a middleman who finds companies that need money and connects them with people who are ready to provide a loan,.
Platforms do not take obligation towards investors to asses project financial, market, and other business risks, they act like eToro in stock trading, and they facilitate translation and make sure that all regulatory requirements are fulfilled.
Given the mentioned, it might seem that the platform role is not that important, but it is not really so!
Yes, you as an investor have to take risks and responsibility for evaluating the project, but platforms can substantially improve this process.
Based on which parameters to choose a crowdlending platform?
Let’s review key parameters based on which you have to evaluate crowdlending platforms both from a regulatory prospective and best market practices to ensure the platform provide the best transparency and usability.
Crorwdlednig platform regulation:
All crowdlending platforms in the EU must be regulated some have obtained or switched to new Europen Crowdfunding service provider regulation (ECSP), and some are continuing to work under old regimes. I will be honest I have not evaluated all “old regime” regulations and I cannot say 100% which regulation id better for investors, but I have explored 100s of platforms and I would say that the data quality of platforms under new regulation a significantly better, both data about platform performance and projects. So I would choose platforms witch operate under new regulations and ofcourse if some platforms are not regulated I would not recommend using them.
Crowdlending platform statistical historical data
Before new regulations platforms were providing data about how many projects were financed, the funded amount, average interest rate, and rarely some provided also statistics on loan overdue days.
Volume data and offered return data are important but it do not provide whole picture and thus investors cannot make data driver decisions.
With a new crowdfunding regulation situation improved significantly. Platforms now have to provide clear data on historic default rates and losses etc. which is crucial for evaluating investment.
Should be mentioned that all banks do this, they collect historical data on their portfolio and try to make an estimation for the future. For example, if in the last 3 years bank financed 3000 companies with a risk grade of B and 5% of them went default and the bank lost 50% from each defaulted loan, it is fair to say that B-rated companies will have a 5% default probability in the next year and 5 of 100 companies will default and loss given default will be 50%. Banks use this information to set pricing that will ensure that loss from that 5% will be covered by others and you should do the same.
Therefore when choosing a crowdlending platform make sure that the platform provides the required data and then evaluate it:
- I would say the default rate for SME loans should not exceed 10%-15%, if it is more then it is an indicator that the platform does a bad job at selecting loans;
- Loss from defaulted secured loans should not exceed 30-50%, if it is above most likely platform does a bad job evaluating collateral value;
Note: If the platform operates for several years and has funded a significant amount and the default rate is 0% most likely something is wrong since even large corporate loans have default rates of 2-3%. Thus they either provide the wrong statistics or the platform prolongs loans so they do not default or be late, or they refinance bad loans by posting another loan on the platform.
Risk scoring and methodology of crowdlending platforms
The platform can (not obligated) assign ratings for each project based on their creditworthiness and probability of default which could significantly improve investors' experience and allow them to quickly select a project if they trust the rating.
In such cases, investors should in detail evaluate a method of how rating calculation is performed and new regulations have set requirements to provide detailed descriptions of scoring methods which make it easier and more transparent.
To sum up, platforms with ratings provide a much better user experience but you have to check their methodology and always double-check their work.
Information about crowdlending project
The crowdlending platform has to provide information about the project so you can understand key potential risks and their probability. Under new regulations project owner has to provide a so-called key investment information sheet that should include information about borrowers, financial data, risk factors, investor rights, etc. which makes it much easier to evaluate and compare, but platforms can request and provide even more data and a lot of platform do so.
I would say that when evaluating each lending project you have to answer these questions:
Market risk: given the competition and market conditions will the company be able to outperform competitors and reach planned results?
Business model risk: given the company's supplier, buyer risk, and sales model will the company be able to reach planned operational results?
Regulatory and compliance risk: is the company subject to regulatory and compliance risks and what is the risk of the company not meeting set requirements?
Management risk: will management be able to reach the required results?
Financial risk: Given mentioned above will company be able to meet the required debt service capacity?
Collateral: if the company will not be able to meet the required debt service capacity and will default, will collateral value be sufficient to cover the company's obligations?
Therefore I would suggest looking for a platform that does an extra step and provides information in a way that you can easily find an answer to the questions above.
Operational risk of crowdlending platforms
Operational risk is a big part of lending businesses. There are countless operational risks, that might occur and that should be managed, like collateral being damaged and losing its value, lent money spent on a different purpose, collateral not being properly registered, and so on.
Thus when choosing a platform you need to explore how platforms make sure that collateral is protected, and that the borrower will be able to finish the project, and that all paperwork is done properly.
Crowdlending platform reputation
Always explore what other people say about the platform. There are many risks or potential issues that cannot be explored before you start using the platform. Therefore read other investors' reviews and complaints to find the best platform possible.
We at Crowdinform.com are aggregating user reviews and ratings for 500+ European platforms, thus if you plan to use the platform read reviews on Crowdinform and if you using some of the platforms please leave a review to help others make better investment decisions - Crowdlending platforms review.
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Remember: Direct and indirect investment in crowdfunding involves significant risks as there is a potential risk for loss of part or all of the invested capital.
We wish you a good day and successful investing!
CrowdInform
