ALTERNATIVE INVESTMENT REPORT ALTERNATIVE INVESTMENT A

i R ALTERNATIVE 2015/2016 FINANCE 15/16 FOREWORD Welcome to the first alternative finance industry report, written for retail financial services professionals. EDITORIAL Daniel Kiernan Writing this report has been a lot like trying to hit a moving target Samantha Goins because the world of alternative finance changes fast and there are so many developments: new platforms, products and innovations; new statistics, records and research; wraps, regulations and tax treatment... the list goes on, making it difficult to get your arms around the whole- of-market and develop a full understanding of the sector.

This might not be an issue for the two categories of investor who CREATIVE have been attracted to alternative finance so far: small retail Mar Alvarez investors who are early adopters and big institutions that have the resources to carry out thorough research before deploying their capital. However, we think that it IS an issue for retail financial services professionals: regulated advisers, SIPP, SSAS and ISA providers, wealth managers, compliance firms, accountants, tax specialists and sophisticated investors.

SUB-EDITING Guy Tolhurst There is a huge amount of wealth that sits in this retail financial services bucket and there will be big benefits for both investors and the alternative finance industry if that wealth can be deployed by alternative finance - but there are unique challenges to overcome before that can happen.

RESEARCH Samantha Goins Anyone operating in professional retail financial services is heavily Derek Skrzypek regulated and has treating clients fairly and consumer protection Derek Casanas at the heart of everything they do. They won’t ‘dabble’ with their Aditi Surana clients’ money. Furthermore, they don’t have the resources to do the research that is required to allow them to enter the asset class with confidence. This report has been written with this group in mind. We want to provide an accurate summary of where the alternative MARKETING Alex Evans finance industry is today, how it got there and where it might be Michelle Powell headed. We look beyond the volumes deployed by the platforms and DISCLAIMER PUBLICATION outline the various models on offer and assess the risks and benefits This report is provided for general The information has been compiled from associated with them. We discuss how to conduct due diligence on information purposes and for use credible sources believed to be reliable, alternative finance, what to look for and what questions to ask. only by investment professionals however it has not been verified and its We solicit the opinion of industry insiders and forward thinking and not by retail investors. accuracy and completeness are PRINT Four Way advisers - both optimists and sceptics. We look at regulation and not guaranteed. Reliance should not be placed on the Print what that has done to the market, and we consider how this asset information, forecasts and opinion set The opinions expressed are those of class will start to fit into the retail financial services landscape. out herein for any investment purposes Intelligent Partnership at the date of and Intelligent Partnership will not publication and are subject to change accept any liability arising from such use. without notice. Guy Tolhurst Managing Director Intelligent Partnership is not authorised No part of this publication may Intelligent Partnership and regulated by the Financial be reproduced in whole or in part Conduct Authority and does not without the written permission give advice, information or promote of Intelligent Partnership. itself to individual retail investors. COPYRIGHT © INTELLIGENT PARTNERSHIP 2015

2 2 3 “Advisers need good quality information – about the nature of EIS, about the practical process of CONTENTS EIS investing and about the many ways of using EIS as part of a broader financial strategy. We see providing this sort of information as a central part of our relationships with financial advisers.” Andrew Sherlock

A. Octopus Investments was by far the most widely known EIS manager with 95% of advisers having dealings with them. This is likely due to their track record and existence in the EIS market for a number of years. Other well-known managers include Ingenious Media with 58% and Oxford Capital and Foresight, both with 42%, and managers with a smaller presence including MMC with 11%. It appears advisers stick to managers that they have had previously INTRODUCTION OVERVIEW INVESTING IN ALT FI Source: Intelligent Partnership INDUSTRY ANALYSIS CONCLUSIONS APPENDIX good experiences with, making it hard for new entrants or competitors to attract these advisers. Many of the advisers questioned had not used a manager that wasn’t listed above. Interestingly just over a quarter of advisers use only one EIS manager, but Source: Intelligent Partnership 11% some use as many as 9 and a large number 11% use between 5 and 7 managers. On average advisers use between 3 and 4 EIS managers. Other EIS managers and platforms that advisers use include Kuber Ventures, RAM <40 Capital, Downing, Motion Picture Capital, 40-65 Triple Point and Par Equity. 95% >65 16% l Ordinary Retais 78% 28% Investor HNW and Source: Intelligent Partnership Sophisticated

Yes Q. What category of client do you Q. What age is your average EIS investor? recommend invest in EIS funds? A. The typical age of an EIS investor is between 40 and 65 years old. Investors No A. Advisers were asked whether they in this age group will usually be at (or recommend EIS to HNW and sophisticated approaching) the peak of their working life investors or ordinary retail investors (they (and income), may have children that have 72% could also tick both). Unsurprisingly the recently flown the nest and will be focused vast majority only recommend EIS to HNW on building a portfolio of investments to and sophisticated investors, with only 16% provide for their retirement. They may also seeing them as suitable for ordinary retail have surplus income which they can afford Source: Intelligent Partnership to allocate to riskier investments such as EIS investors. in the search of higher returns. EIS investments generally involve a large Only 11% of advisers recommend EIS amount of risk and capital can be tied Q. Do you feel that there are enough investments to investors below the age of up for a number of years. The tax reliefs 40 or above the age of 65. Younger investors resources and information available to offset some of this risk, but the majority of may not have the capital to allocate to these enable advisers to achieve whole of the ordinary retail investors will not be higher types of investments as they are likely to market knowledge of the EIS sector? rate tax payers and therefore will not be focused on buying a property and/or receive the maximum benefit from these tax starting a family. However, there is potential A. Being an education and content provider breaks. Therefore HNW and sophisticated for growth from this age group as they pay this is a very interesting question for us. more attention to saving for retirement, and individuals are usually considered a better 72% of advisers feel that there are not they may also have a higher capacity for fit for EIS investments as they will take full enough resources and information available loss, as any losses can be made up through advantage of the tax reliefs available; have a on the EIS sector. Although EIS have been future earnings. greater understand of both the underlying available since 1994 and there are a number investment and the risks involved; and also Investors in the over 65 age group are likely of well-established managers in the market, to be in retirement and therefore would not have a greater capacity for loss should the advisers feel that they still do not have take on investments that could risk their investment fail. enough resources to gain the whole of retirement income. They may consider EIS market knowledge they require to fully for the 100% Inheritance Tax relief available understand the sector and recommend though. these products to their clients. It seems 37 there is definitely scope for more education and training in this space, which should ultimately improve the market for everyone THE PLATFORMS involved. 56 58 PERFORMANCE

60 TRANSPARENCY 30 RISKS OF ALT FI 61 THE CONSUMER JOURNEY FOREWORD 3 35 PLATFORM MELTDOWN 63 COMPARING THE BIG THREE OVERVIEW OF REPORT 6 12 THE ALT FI UNIVERSE 38 RISK MITIGANTS 66 DEFAULTS 78 GLOSSARY OF TERMS 7 ACKNOWLEDGEMENTS 14 OVERVIEW OF ALT FI 42 PLATFORMS IN FOCUS 68 ADVISER SURVEY 79 BIBLIOGRAPHY 8 EXECUTIVE SUMMARY 17 THE INVESTMENT CASE 50 GUIDANCE FOR ADVISERS 71 PLATFORM SURVEY 76 CONCLUSIONS & OUTLOOK 80 ALT FI PLATFORM REGISTER 10 KEY FINDINGS 20 ALTERNATIVE FINANCE IN 2015 54 CONCLUSIONS 73 INVESTOR SURVEY 77 SWOT ANALYSIS 86 CPD AND FEEDBACK

* Please note: unless otherwise stated, all charts and graphs have been provided by Intelligent Partnership

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4 5 OVERVIEW ACKNOWLEDGEMENTS

Our intention is not to provide the We’ll also look at some of the big And that’s basically it 37,000 words We couldn’t do this without the help and support of a number of third kind of market statistics that AltFi developments that are happening right over 80 pages with lots of explanatory parties who have contributed to writing this report. Their contributions Data does (although we do leverage now and have really big implications for charts and diagrams thrown in. If it’s range from inputting into the scope, sharing data, giving us their insights some of their work), or to produce the how alternative finance develops - from all new to you, by the end of the report into the market, providing copy and peer reviewing drafts. Their input is kind of academic papers that NESTA ISA and SIPP acceptance, to high street you’ll have a great understanding of invaluable, but needless to say any errors or omissions are down to us. and the do referral schemes and the influx where this industry stands today and (although they are a crucial resource of institutional money. We’ll give our what it means for you. And if you’re a for us). Our intention is to view the view of what we think is good and bad veteran of the scene, it will summarise asset class through the eyes of retail about all of these exciting changes. some key issues all in one nice handy financial services professionals and document, and hopefully present There’s a section that looks at things provide some of the answers they some new research and ideas for you. SO A BIG THANK YOU TO: specifically from the point of view of will require if they are to successfully investors and advisers, and we think By the way - we’re focusing on UK engage with alternative finance. about the practical steps they can based platforms here. We touch on The report doesn’t have to be read take if they want to get involved in the overseas alternative finance markets, cover to cover, from start to finish - it’s sector. Frankly, it’s not an easy task and some of our UK platforms are not a novel and you can get just as for advisers to invest their clients’ branching out internationally (and much value from it by dipping in and money in alternative finance at the given the online nature of alternative out of sections that take your fancy. moment, but we reckon that more and finance, it easy for investors to access For those of you who like to get a really more of their clients are going to hear overseas platforms), but this report is quick summary of what we have to say, about it, and it’s going to be an asset all about the platforms UK investors the key findings are on page 10, the class that more and more of them will can invest in right now, based here. executive summary is on page 8 and the invest in. Advisers need to be wary of conclusions and outlook are on page 74. clients developing satellite portfolios in alternative assets that are not part However, the report does follow of their assets under influence, as they a logical order - we’ll start at the won't form part of any valuation of beginning by defining just what the adviser's business. As a minimum alternative finance is, where it sprang advisers should ensure they have a from and where it’s at today. We’ve working knowledge of the sector so that tried to structure the report so that we they can discuss it with confidence. start off at a very high level, and then go into each topic in a little bit more As with all of our reports, we’ve been depth as the report goes on. So even out there and surveyed the opinions if you are starting from a position of of some of the big stakeholders - in no prior knowledge at all (we know this case we conducted one survey to from talking to advisers that this is establish the levels of awareness of exactly where some of them are at) the alternative finance amongst advisers report will still be readable and useful. and another survey to see just what the And if you already know the basics, alternative finance platforms thought there’s also some in-depth analysis of advisers. We also carried out “meta for you to get your teeth into. (Note studies” (looked at the other available for newcomers: there’s also a glossary research) of investors and potential SME at the back if you find yourself getting investee companies and finally surveyed confused by some of the terminology). SIPP operators to complete the picture.

We’ll go on to assess some of the Finally, our market analysis is what benefits and risks of investing in drives a lot of our commentary - we alternative finance and take a deep dive take a thorough look at the platforms into the surprisingly diverse alternative and products that are out there to investment universe - there is a huge build a complete picture of what variety of business models and USPs comprises the market for investors out there and one of the myths we right now, and we share that with want to dispel for our readers is that you in the market analysis section. all the platforms are the same.

6 7 “Peer-to-Peer lending has become an innovative and accepted alternative to traditional savings and investment products. Very soon it will cease to be viewed as alternative finance, but EXECUTIVE SUMMARY mainstream" John Goodall, Landbay

OK, enough preamble - let’s get down to brass tacks. What have we found out? #4. ALTERNATIVE FINANCE HAS THREATS AS WELL AS OPPORTUNITIES #1. ALTERNATIVE FINANCE IS GROWING FAST CONSOLIDATION Well, you probably already know that in 2013 to £1.74 billion in 2014 (Source: over £100 million. And this is not a trend FAILURE even though alternative finance accounts ‘Understanding Alternative Finance’, that is slowing down - take a look at the FRAUD VERTICAL INTEGRATION for a very small percentage of the retail NESTA and the University of Cambridge). growth curve on the chart below. There’s OVERSEAS EXPANSION lending, business lending and equity AltFi Data measures the cumulative total more on the growth of the market on CAPITAL RAISING fundraising markets, it’s growing fast: amount of money deployed by the peer- page 28. REGULATION the market doubled in size year on year to-peer lending market at over £4 billion from £267 million in 2012 to £666 million and by the market at The alternative finance industry is still developing - it’s probably not even half way along this growth curve Source: Mark James, PwC

Does the sector suffer from a bit of fraudsters successfully targeting On the other hand, opportunities for the (2006-2015) LIBERUM ALTFI VOLUME INDICES hubris? We think some parts of it do, the industry; platforms failing to sector include the introduction of retail Cummulative volume £m P2P Consumer Lenders P2P Business Lenders Liberum AltFi Volume Index Crowdfunding and it occasionally feels a bit like the comply with regulation as they move investment products, using the ‘big data’ £4b dotcom scene in ‘99. There’s inevitably from interim permissions to full they hold on consumers to develop going to be a shake out at some point in authorisation; higher than forecast ever more accurate credit scoring

£3b the near future. lending losses in the peer-to-peer algorithms, tie ups with mainstream sector; or consumers getting ripped off finance and ‘challenger’ , and Potential threats that we see hovering in the crowdfunding sector. We think tie ups with online behemoths such £2b over the sector include: a platform that some of these threats will take out as Amazon or eBay. Check out our failure due to undisclosed losses; a some of the platforms, leaving behind SWOT analysis on page 75 and our loss of consumer data or a platform a smaller, more consolidated and more outlooks and conclusions on page 74. £1b falling victim to a cyber-security attack; resilient alternative finance industry.

#5. ALTERNATIVE FINANCE CAN HELP THE ECONOMY 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 The government estimates that there PLUGGING THE FUNDING GAP Volumes in the Alternative finance market have grown exponentially Source: AltFi Data 2015 is a £1bn annual funding gap for SMEs 400 £250m £260m £268m in the UK, and alternative finance is £179m

#2. ALTERNATIVE FINANCE IS MATURING 200 helping to address that. According to £) As the sector is growing, it is also products, regulation and the deployment unique challenges with them and it's AltFi Data, the UK’s peer to business £m maturing. We think that key milestones of taxpayers’ money via alternative not clear to us that all of the platforms 14Q1 14Q2 14Q3 14Q4 lenders provided £339 million of -200 such as the bank referral scheme, finance are all indications of a maturing really appreciate that there are a lot £-128m capital to UK SMEs in the first three

SIPP and ISA acceptance, institutional market. However, each of these of potential pitfalls ahead. We discuss -400 months of 2015 and have consistently investment, creation of retail investment developments also brings their own these developments on page 9. £-339m outperformed the government’s -600 Funding for Lending Scheme. Read more Quarterly volume ( -800 £-732m about the benefits for small businesses Launch Brewdog First P2P -800m First First Launch of FLS P2P Business Lending on page 28 and some more of the crowdfunder market data of funds record platform to P2P Alternative Finance can help plug the funding gap non-financial benefits of investing in indices investing crowdfunding lend over lender (CROWDCUBE) alternative finance on page 18. (ALTFI) in P2P raise £1bn Source: AltFi Data (alfidata.com)

#6. ALTERNATIVE FINANCE CAN PROVIDE UNCORRELATED, LOW VOLATILITY INCOME & GROWTH ALTERNATIVE FINANCE MILESTONES LIBERUM ALTFI RETURNS INDEX (2006-2015)

First Banks Cumulatively, ISA 6.5% provision fund Regulation mandated to P2P breaking acceptance (RATESETTER) refer customers through £4bn 6.0% to P2P barrier 5.5%

5.0%

#3. ALTERNATIVE FINANCE IS NOT A HOMOGENOUS ASSET CLASS 4.5% 2006 2007 2008 2009 2010 2011 2012 2013 2014 4.0% This is not a homogeneous asset a healthy market that has something to models and what we believe the pros and Source: AltFi Data 2015 class. There are over a dozen different offer everybody. However, each variation cons of each are on page 38, we discuss Finally, we shouldn’t forget investment basics. Peer-to-peer investments offer the prospect of lower levels of volatility and higher yields operating models in the market and has its own risks and rewards making the risks and benefits of the sector on that are not necessarily correlated to the mainstream bond and equity markets. According to the Liberum AltFi Returns Index (LARI) – as well as generalist funding platforms it harder to get your arms around the page 31 and we suggest a due diligence the only index to track actual investor returns in the sector, the aggregate absolute net return over the last three years from the three there are five specialists. We think that whole-of-market, which is a problem process on page 48. biggest UK peer-to-peer lenders is 18.05%. opens up an asset class that was previously out of reach for many retail this diversity is excellent and the sign of for advisers. We go through the various investors, giving them access to some significant tax breaks and the potential for some very high returns on the successful investments.

8 9 KEY FINDINGS

In the UK, alternative finance Total investments in 2015: is the has originated over 18.05% £4.6bn aggregate absolute return of investments to date £2.29bn over the last 3 years from the OVERVIEW 3 biggest UK peer-to-peer lenders (as at 30 September 2015) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

Crowdfunding Peer-to-peer NO OF PLATFORMS has originated lending 55 P2P 33 £145m has originated CROWD- FUNDING £4.8bn

INVOICE2 £145m £4.8bn FINANCING

P2P MARKET PEER-TO-PEER PLATFORMS CROWDFUNDING MARKET NOV 2015) (NOV 2015) offer forecast yields ranging (

ZOPA 24% from 4% - 15% a year and CROWDCUBE 36% terms from 6 months to 19% SYNDICATE ROOM 19% 5 years RATESETTER 18% CROWDBNK 3%

CROWDFUNDING offers CROWDFUNDING offers There are 3 funds investing in investors low cost access to access to AIM and ISDX alternative finance listed on the London Stock Exchange tax reliefs in the form of EIS listed shares, which can be held in ISAs and qualify for and SEIS benefits relief from inheritance tax

has already of the advisers we of platforms either 93% plan to market deployed over surveyed were not aware to advisers in the in the alternative that alternative finance 73% future, or do so £200m platforms are regulated finance market already

If you only read this far, we’d still like to think that it’s been useful and informative for you and you can see what we’re trying to

achieve here - we want one single, comprehensive and well researched overview of this emerging asset class that looks at things from the �perspective of the advisers and financial services professionals who serve retail investment consumers. If you read on we'll flesh out this picture for you, so that by the end of the report you can talk to your clients knowledgeably and with confidence.

10 10 11 “2016 is a great time to start investing in the peer-to-peer lending industry – as the market continues to mature, investors can conduct due diligence on the platforms’ track records, credit processes and lending THE ALT FI UNIVERSE discipline; giving investors greater confidence over the sustainability of returns" Stephen Findlay, BondMason

In this section we’ll define exactly They leverage the scale of online Unhelpfully, the FCA used different SUMMARY OF ALTERNATIVE FINANCE MODELS what we mean by alternative finance platforms to secure lots of lenders and terminology in its policy statement and identify the sub-sectors that sit investors at low cost on alternative finance PS14/04. It had DEBT EQUITY underneath this umbrella term, and crowdfunding as its umbrella term, and They are not investors themselves - then after a brief run through the classified the market into based INVOICE FINANCING PEER-TO-PEER LENDING DEBT SECURITIES they help their members invest their history of the sector we’ll give you crowdfunding and investment based own money P2C P2B some stats to show you where it’s at crowdfunding. Individuals buy Individuals buy Individuals buy today and who’s investing. *There are exceptions, but we’re Individuals lend shares in early The term marketplace lender needs invoices at a Individuals lend security, normally sticking to general statements in the money to other stage business explaining. It’s used interchangeably discount, then money to business a form of bond, to name of keeping things simple at this individuals to for capital growth WHAT IS ALTERNATIVE with peer-to-peer lending and has sell them back to to earn interest and earn interest and early stage in the report! We’ll deal with earn interest and or dividends FINANCE? been a more US-centric term because firms at a profit their capital back their capital back the exceptions in later sections. their capital back Alternative finance is an umbrella the market there has a much heavier Source: P2PFA (2015) term that covers a range of very TAXONOMY #1 weighting to institutions rather than Breaking down alternative finance different models for deploying Breaking Down Alternative Finance individuals. With more institutional capital to people who need it. The money now coming into the UK WHAT ARE THE MOTIVATIONS OF THE be overcome in the future; this is a the same for the last 130 years (Thomas Right at the top, there is a clear distinctions between these models alternative finance industry, more PLATFORMS? fundamental change for the better Philippon, Professor of Finance at the distinction between platforms who are and more platforms are referring to and should be supported by the Stern School of Business). are important and we’ll cover them in The platforms’ motivations range from facilitating lending, and those that are themselves as marketplace lenders. regulator and government, applauded more detail later on in the report, but a genuine desire to give a better deal So while alternative finance does facilitating investment in equity. Lending This is probably a good development as by consumers and carefully noted by the majority* share four important to consumers, to giving a better deal compete with incumbent lending and activity is referred to as peer-to-peer- the term peer-to-peer lending implies incumbents. features: to SMEs and early stage companies, investing institutions what it is doing is lending (P2P) or marketplace lending, something different to what is actually The platform operators are ‘digital’ to trying to plug a funding gap in a TAKING ON THE BANKS? bringing about fundamental changes and can be broken down into peer-to- happening on lending platforms where businesses -their model is web-based particular sector. (But don’t doubt that in how consumers can access markets business, peer-to-consumer and invoice institutions are also playing. An even It’s also worth pointing out that despite there are some “me too” opportunists -but we don’t buy any anti-bank/anti financing. Equity fundraising is referred more nuanced definition would be: some of the “anti-bank” rhetoric the They are not banks or other in there as well now that the sector is fund management rhetoric. Rightly or traditional financial services to as crowdfunding and includes a sub sector dispenses, the more mature Peer-to-peer lending: consumers starting to take off). wrongly, Barclays and HSBC are not institution sector that issues debt based securities platforms are not anti-bank. They and institutions are the lenders about to go the same way as HMV and as well as company shares. understand that there are important GETTING A BETTER DEAL FOR Our Price because of digital disruption... Marketplace lending: institutions CONSUMERS? differences in the risks to the lender (the WHERE DO “DEBT BASED SECURITIES” FIT IN? are the lenders risk is WITH the lender, NOT the bank) PLUGGING THE FUNDING GAP? From the consumers’ point of view, and their objective is only to offer an Balance sheet lending: the platform The government estimates that there PEER-TO-PEER LENDING CROWDFUNDING they have never had access to markets alternative asset class for consumers, is the lender is a £1 billion annual funding gap for where interest rates are set, or access not to somehow replace banks. SMEs that needs to be plugged. This So it’s important to understand exactly to affordable opportunities to invest in Alternative finance doesn’t is significant for the UK: at the start of what the platforms do: most do not early stage companies before. To access disintermediate the banks: all of the 2014, small firms accounted for 99.3% take on the risk of the or equity the yield from issuing credit they had to money stays within the banking system of all private sector businesses, 47.8% of investments themselves. They originate accept an asymmetric relationship that one way or another. What peer-to-peer private sector employment and 33.2% deals for either retail consumers or favoured their bank. And to invest large lending does do is compete with banks’ of private sector turnover. Small and institutions, or both. They have a variety sums they had to go through expensive PEER-TO- PEER-TO- INVOICE EQUITY ISSUING lending departments. In the equity medium sized businesses employed of ways of doing this, which we will fund managers to access the potential CONSUMER BUSINESS FINANCE CROWDFUNDING SECURITIES crowdfunding space the platforms are 15.2 million people and had a combined examine later in the report. Very few returns from investing in early stage usually looking at smaller deals than turnover of £1.6 trillion. (Federation of lend their own money, but this might companies. conventional funds. Small Business). Unlocking the growth change in the future – if inflows from Now this report isn’t an anti-bank/ If they are competing with anybody potential of this sector will have a big lenders slow down (as they must do anti-fund management polemic: for deals, it is with angel investors. positive impact on the UK’s economy. eventually), platforms might need the both of those conventional ways of However, the lending and investing capability to lend their own (or more accessing these asset classes have But banks and investment funds don’t PEER-TO-PEER EQUITY parts of financial services feel like an likely, their owners') money. great advantages, and we’ll highlight really want to step in and plug this gap. DEBT-BASED industry that is ripe for disruption: LENDING CROWDFUNDING The British Business Bank estimates SECURITIES And the lending platforms are not the differences between them and the Fewer than 1 in 3 customers trust that 500,000 SMEs are deterred or banks. The platforms undertake some new world of alternative finance in the their bank (PWC) declined for finance every year. of the activities that have traditionally risks section later on. But the alternative been the sole preserve of banks, but finance industry has been able to UK retail investors pay nearly 60% that’s as far as it goes. Any marketing democratise finance and open up more for their investments than in the that suggests they are an alternative to asset classes to retail investors. This is US (True & Fair) banks (from the lender's point of view) important. Whatever other weaknesses Despite computerisation and Some commentators classify debt based securities as crowdfunding, some as lending needs examining carefully. there might be with alternative finance models, and whatever headwinds colossal economies of scale the cost of and occasional storms will have to intermediation in finance has remained

12 13 “The "excitement" phase is probably over and we are now entering the "execution" phase as the OVERVIEW OF ALT FI industry matures and starts to enter the mainstream"

Since the financial crisis in 2008, banks (or almost throughout) the entire objective of making money as well, The University of Cambridge estimated have been reluctant to lend as they try business cycle. Funding Circle launched and how much they have remained in that this would grow to around £4.4 CONSUMER AWARENESS SME AWARENESS and repair their balance sheets and in 2010 and was the UK’s first peer- keeping with this grassroots feeling is a billion by the end of 2015, and by 42% 58% 44% 56% regulation has also played its part. The to-business lending platform, and matter for debate, but there is no doubt October, the number was already at Basel Accord requires banks to hold RateSetter, the first peer-to-peer lender that the rapid expansion of the sector £4.8 billion (Understanding Alternative 9% significant amounts of capital against to use a contingency fund to protect has its roots in this period 2008 - 2014. Finance, University of Cambridge, 2014). risky assets, and lending to small firms investors, also launched in 2010. These They support this with stats showing According to our research, the number 44% is hard work - large firms take bigger are not only the originals; they are also that awareness and usage of alternative of alternative finance platforms grew sums of money for longer periods of currently the biggest players in the UK finance is still quite low. According to from 4 to 94 from 2008-2014 (2,250% time and have more assets to secure alternative finance market. surveys 42% of individuals in the UK growth!) and at the time of writing the 14% loans against, making them much more are completely unaware of any type Crowdcube is widely recognised as the number has settled at 102 platforms. "lendable". Similarly, in the venture of alternative financing activity and first crowdfunding platform, launching During this period of rapid growth capital world, funds are usually looking only 14% have ever used an alternative in 2011 and MarketInvoice, the first we started to see the explosion in the Unaware of any type of alt fi Unfamiliar with any type of alt fi to make bigger investments of at least finance platform. And among SMEs, 56% invoice trading platform, launched the number of different innovations and Aware of some type of alt fi Familiar with some type of alt fi £3million plus. are unfamiliar with alternative finance same year. business models as platforms innovated Aware of some type but have not used it Have tried to use some type of alt fi and fewer than 10% had approached a Have used some type of alt fi All of this leaves an underserved and looked to carve out specialist niches platform. market of SMEs that alternative finance THE “EXCITEMENT” PHASE: 2008 - 2014 or unique selling propositions in the Source: University of Cambridge (2014) Source: University of Cambridge (2014) providers can step in and provide either new asset class. The majority of consumers have not The majority of SMEs have not used credit or equity funding to. By using PLATFORM GROWTH invested in alternative finance alternative finance THE “EXECUTION” PHASE: technology to drive their overheads 120 WHO’S INVESTING? ALTERNATIVE FINANCE TODAY and costs per loan down, alternative 100 We’ll deal with the influx of institutional money into the UK alternative finance industry later, but it’s interesting to pause and see investment providers are better able to The "excitement" phase is probably over what kind of retail investors have been investing to date, and again the University of Cambridge have some useful research here: serve this market. 80 and we are now entering the "execution" phase as the industry matures and starts Finally, it’s worth mentioning speed 60 (2014) to enter the mainstream. We’ve identified AGE OF FUNDERS here. From the investee companies’ 40 88 platforms currently operating in the point of view, whether they are selling 20 UK now and according to AltFi Data over 38% 40% 43% 55% 57% 40% 56% equity or borrowing money, the £4.8 billion of loans and investments 36% platforms can offer a much swifter 0 40% 43% 36% 37% 35% 40% have been originated to date. 33% 31% 40% 39% solution than traditional sources - a 33% 31% 39% timing issue which can be the difference 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 THE UK MARKET TODAY between success and failure for some Platform growth accelerated after 2010 25% 23% 22% 12% 12% 20% 5% small businesses. EQUITY DONATION REWARDS P2P CONSUMER P2P BUSINESS DEBT BASED COMMUNITY The two biggest drivers behind the LENDING LENDING SECURITIES SHARES 13% CROWDFUNDING CROWDFUNDING CROWDFUNDING HISTORY growth of the alternative finance market were probably ‘Web 2.0’ and the 3% Under 35 35-54 55+ Source: University of Cambridge It’s important not to get too carried financial market crash of 2008. away with the "newness" of alternative A broad cross-section of age ranges have invested in alternative finance, but the over 55s dominate lending, perhaps attracted by the finance, or promises of disruption to the Web 2.0, along with the widespread 42% combination of low volatility/high yield incumbent financial services industry. adoption of broadband by households, Facilitating the efficient allocation of got people used to the idea of forming ANNUAL INCOME OF FUNDERS (2014) capital is about as old as capitalism online communities, researching and itself, and raising money from "the pursuing their own interests and doing 42% crowd" goes back at least to medieval much more than ever before online. cathedrals. Of course the on-line The 2008 crash prompted a search for EQUITY DONATION REWARDS P2P P2P DEBT BASED COMMUNITY CF CF CF BUSINESS CONSUMER SECURITIES SHARES element is new, but even that has been new asset classes as investors became traced back to the British rock group disillusioned with the volatility of the Source: AltFi Data , as at 10/11/2015 Marillion, who raised £40,000 online stock market, "bankers" and the culture to fund a tour back in 1997. So the of "the city". P2P Consumer Lenders - £2,067,358,302 <£15,000 £15,000-£25,000 £25,000-£35,000 £35,000-£50,000 £50,000-£100,000 £100,000-£150,000 >£150,000 concepts behind alternative finance are It was seemingly in this spirit - using the P2P Business Lenders - £2,083,587,952 People from a broad cross-section of income brackets have invested in alternative finance Source: University of Cambridge not brand new. web to reach out to people and form Invoice Financing - £664,119,400 The charts don’t need much additional comment - clearly a wide range of age groups and income brackets are investing, and younger The first peer-to-peer lending platform communities and invest money in a Crowdfunding - £144,942,904 folks seem keener on equity crowdfunding while the more risk adverse older generation lean towards peer-to-peer lending. was , founded in 2005 - which more democratic or impactful way - that makes it the only alternative finance lots of new alternative finance platforms The makeup of the alternative finance And how many people are investing? Well it’s not possible to generate a 100% accurate number, but AltFi Data had a good stab provider to have operated throughout launched. Of course they all had the market in the UK at it in April 2015 and came up with somewhere between 90,000 and 110,000 investors in UK peer-to-peer lending, with average portfolio sizes across the various platforms ranging from £6,000 to £125,000.

14 15 "What the platforms have done that is new, is to open up these asset classes in a way that is simpler, more transparent, cheaper and easier to access than ever before" THE INVESTMENT CASE

WHY ARE THEY INVESTING? So we’ve established, at a high level, HIGHER INTEREST RATES MOTIVATIONS FOR PEER-TO-BUSINESS LENDING what alternative finance is, where it has Yet again, the University of Cambridge Consumers are also likely to get a better deal - lending platforms’ costs are much lower To make a financial return come from and who’s investing in it. Now have done the hard work surveying To diversify my investment portfolio than traditional banks so consumers can usually earn a higher rate of interest on their we’re going to examine the investment consumers. Supporting an alternative to the big banks investments, as the charts below from investment bank Liberum demonstrate: To have control over where my money goes case for the peer-to-peer lending and Traditional investment motivations such The ease of investment/lending process crowdfunding. We’re still going to keep The choice of various loans on offer as returns and diversification are still things at a fairly high level for now - I feel my money is making a difference PEER-TO-PEER PLATFORMS HAVE LOWER COSTS THAN BANKS paramount across all these alternative Supporting the SME sector we’re not going to dive into the different OPEX/Total Balance Outstanding (bps) 100 695 finance sectors, but factors such as Lending to industries I know/care about models the platforms use, and we’ll save 700 Doing social or environmental good Banks transparency, access, control and non- looking at the sorts of things that should 35 Lending to local businesses/enterprises 600 30 financial motivations also score highly. Peer-to-peer 30 Curiosity be part of your due diligence until a little 100 Supporting a friend or family member later in the report - but we are going to 500 This chimes with the Great British To help increase housing stocks look at the overall benefits and risks of 170 Money Survey (commissioned by 400 % 10 20 30 40 50 60 70 80 90 100 investing in alternative finance. crowdfunding platform Abundance Financial returns are still a crucial motivation Source: University of Cambridge (2014) 300 135 270 Generation) which has found that 60% of 220 10 people want to know where their money PEER-TO-PEER LENDING 200 29 MOTIVATIONS FOR PEER-TO-CONSUMER LENDING 28 is invested, 62% want to be in control of You will hopefully have gathered by 20 100 19 their money and chose exactly where Interest rate available now that what peer-to-peer lending 39 it goes and 58% would be unhappy if Knowing my money is protected by provision platforms are really doing is opening 0 their money was used for unethical I can choose how much to lend and for how long up an asset class for consumers that Branch FDIC CS/ Origination G&A Other IT Marketing Total Supporting an alternative to the big banks activities. It also found that only 1.5% of promises high yields (in comparison to Collection Opex Ease of use investments offered by banks are ethical deposit interest rates) and low volatility. Source: Liberum (2014) To diversify my investment portfolio - from this perspective the appeal of Level of customer service ACCESS TO THE LENDING MARKET alternative finance is clear. Knowing my money is helping someone DEPOSIT RATES VS. PEER-TO-PEER NET YIELDS Access to secondary market Peer-to-peer lending is no different to 6% CONCLUSIONS Curiosity any other kind of lending. Investors 5% Once you get past the new jargon, at lend a principal sum of money to a 4% % 10 20 30 40 50 60 70 80 90 100 its simplest level alternative finance is borrower - either a consumer or a 3% Source: University of Cambridge (2014) not doing anything new: the platforms Peer-to-consumer lending interest rates are attractive business - who will pay them interest 2% are either lending money to businesses and then return the principal either at 1% and consumers or buying shares in a the end of a predefined period, or in a 0% MOTIVATIONS FOR INVESTING IN EQUITY CROWDFUNDING business. series of repayments throughout the Instant Cash Cash ISA Fixed rate Fixed rate Zopa RateSetter Funding The prospect of financial returns term of the loan. Most folks are actually Access ISA 1yr fixed bond 1yr bond 2yr 3yr 3yr circle What the platforms have done that is To diversify my investment portfolio already exposed to this market by virtue A lower cost base means that lending platforms can in theory offer a better deal to lenders new, is to open up these asset classes in The ease of investment process of having a bank account - banks take and borrowers than the banks can a way that is simpler, more transparent, To have control over where my money goes in short term deposits from savers and Source: Liberum (2014) cheaper and easier to access than ever I feel my money is making a difference lend them out to long term borrowers. before. This has led to a swift influx of Investing in industries I know/care about BUT DON’T CONFUSE SAVING AND INVESTING The difference in the rate they pay to funds from both retail and institutional Access to deal flow their depositors and charge to their So the real attraction for lenders is the prospect of earning a higher rate of interest investors growing the sector to £4.4 Doing social or environmental good Investing in local businesses lenders is their profit (less their not on their cash compared to banks. But - and it is a big but in our view - peer-to-peer billion in a single decade. And there Curiosity insubstantial costs). lending is NOT the same asset class as a bank deposit. Yes, it disintermediates the is plenty of room for more growth - Supporting a friend or family member banks’ lending departments and yes, it is the same activity - but in peer-to-peer alternative finance accounts for a very It’s this activity of the banks that lending the risk has shifted from the bank, to the lender*. If the borrowers default on small percentage of the retail lending, % 10 20 30 40 50 60 70 80 90 100 peer-to-peer lending disintermediates. the loans, than the lender will suffer the losses. business lending and equity fundraising Source: University of Cambridge (2014) Consumers can now access this market markets in the UK. Even in the high risk world of equity crowdfunding, returns are still a primary motivation directly via their chosen peer-to-peer In short - it makes some sense to compare the returns on offer with bank deposits, lending platform. They can choose who but it is wise to treat peer-to-peer lending as an asset class in its own right. It still Very important Important Neither important nor unimportant Unimportant Very unimportant they want to lend to, how much risk they makes a lot of sense as an investment - high yield, low volatility, relatively liquid and want to take and what interest rates uncorrelated to mainstream markets - just don’t think of it as the same as cash. KEY FINDINGS they want to earn. Instead of being in We’ll talk more about these risks and to what extent they can be mitigated on page 31. Alternative finance covers a range of very different models a relationship where they have very The FCA used different terminology in PS14/04 than the taxonomy used in the industry little power and their choice is basically To be absolutely explicit: when you make a bank deposit, you are technically an Alternative finance does not necessarily disintermediate the banks, but what it does do is compete with their lending limited to “take it or leave it” when it unsecured creditor of the bank. So ultimately, the risk of the bank’s lending book turning departments comes to the interest rate their bank is out to be toxic is with the depositor. But the first £75,000 of any money you deposit with The government estimates that there is a £1 billion annual funding gap for SMEs that needs to be plugged offering, they can now make their own the bank is underwritten by the Financial Services Compensation Scheme, and the banks, decisions. rightly or wrongly, have been implicitly underwritten by the government since 2008. During the excitement phase, the number of platforms grew from 4 to 94 from 2008-2014, a 2,250% growth

16 16 17 “Crowdfunding platforms have been able to lower the minimum investment amounts, lower the “What many people forget is that crowdfunding is about much more than just making a financial transaction costs, reduce the time and effort required to source and select opportunities and cut out return for many investors" Modwenna Ress-Mog, Angel News expensive fund managers and intermediaries"

NON-FINANCIAL BENEFITS TAX BREAKS people rent his drive. In buying shares BUT, BUT, BUT… he gets another connection point with “Currently success in the online KEY FINDINGS This is the "feel-good-factor" of putting And it’s not just access to the None of this makes early-stage the company and he feels good that he equity fundraising market is Peer-to-peer lenders have a money to work in areas that you are investment opportunities themselves investing any easier, and the risks is helping a company that had and is lower cost based that means they keen to support. That might be as that matters here - it’s also access to around establishing the right valuation, measured by the amount of making him money. This is the next stage can offer lenders a better deal simple as lending to SMEs because the generous tax benefits that come illiquidity, lack of dividends, loss of capital raised for early-stage of evolution of the Sharing Economy and they are such an important part of the with investing in this sector. The EIS and investment and dilution are still very Peer-to-peer lending is different we will only see it having more impact on businesses. However, like all economy (if you’ve not been reading SEIS schemes offer relief on income, real. We’ll talk more about these than a bank deposit, as the risk shifts investment over time. asset classes, the real proof of this report from start to finish, there’s capital gains and inheritance tax (via risks and to what extent they can be from the bank to the lender more on this in the previous section), BPR) as well as loss relief on failed Then we must consider novelty value mitigated on page 31. But consider that success as the market matures Crowdfunding allow investors to or it might be specifically choosing investments, but to date EIS and SEIS of owning a piece of a company that perhaps crowdfunding has changed will be the overall return for access valuable tax benefits offered sectors or people that you want to investments have been characterised you identify with. It’s long been known the game for good, and opened up investors. As a result, we would through EIS and SEIS support, such as student finance or by high minimum investment amounts that football fans love to own a share great opportunities for a whole new expect the successful alternative businesses in your local area, for non- that put them beyond the reach of or two in the club they support. You feel generation of entrepreneurs. We’ll financial reasons. As the University many. As long as this is the case, the good with a framed share certificate on also go into detail about debt based investment providers of the of Cambridge survey that we quoted tax breaks are only available for the your wall or tucked away in a drawer crowdfunding, they are a grey area future to be those that evaluate earlier showed, while financial benefits rich. There is certainly an argument with the match brochures, scarves and between equity and debt based the risk/reward profile of are still paramount, the value that that they should be accessible to all sticker books. "Serious" investors need to alternative finance that can eliminate each opportunity, undertake investors place on these non-financial and crowdfunding enables this. understand that the value of a share can some of the risks with equity. benefits should not be underestimated. be more than its face or even exit value. extensive due diligence and can RETURNS CONCLUSIONS Rewards are an interesting aspect of understand the potential future A study by NESTA revealed that the There are two distinct investment cases CROWDFUNDING crowdfunding. In time, the Brew Dog exit scenarios.” returns for angel investors across a for the two distinct brands of alternative Crowdfunding seems to have a fundraising may have been seen as the diversified portfolio is 2.2x the original finance. Both are based around Jamie Beare, VentureFounders knack for generating excitement peak of the crowdfunding bubble, with its investment on average (NESTA, Siding providing low cost, transparent access and disapproval in equal measure. £350m pre money valuation, but if you with the Angels, 2009), and of course to asset classes that were previously Investing in early stage companies is run the numbers on the beer discounts these sorts of figures are big carrots difficult for retail investors to get direct notoriously risky (estimates vary, but on offer to small shareholders, you can for investors. But this comes from a exposure to. it’s reasonable - even generous - to see that for a sociable draft beer drinker, small sample of experienced angel assume that more than half will fail), but buying a couple of shares will pay for In the case of peer-to-peer lending, this investors - the actual performance of course successes can be spectacular. itself within a year or 18 months if you means that in exchange for more risk, of crowdfunding investors is likely Who wouldn’t want a stake, however quaff 4-6 pints of Punk IPA a week. If you retail investors have a very realistic to be much, much worse than this. small, in the next Google or Facebook? have effectively bought your shares for possibility of earning much better risk- Nevertheless, savvy investors might be £0, who cares what the valuation is?” adjusted returns than they are getting ACCESS (AGAIN) able to repeat this kind of performance. with cash, many bonds and other kinds Source: Angel News Issue 122, May 2015 Just like peer-to-peer lending, what NON-FINANCIAL BENEFITS of deposits. crowdfunding does is open up this asset Over to Modwenna Rees-Mogg at In the case of crowdfunding, retail class to retail investors for the first time. VC FUNDS Angel News: investors can support early stage Previously these opportunities were the We would not be surprised if some businesses and maybe pick out some preserve of business angels, or (for the “What many people forget is that traditional venture capital firms see winners. The investment case is bigger opportunities) venture capital crowdfunding is about much more than the development of crowdfunding weaker, but that’s mitigated by very low funds, but crowdfunding platforms just making a financial return for many as a positive for them, rather than as minimum investments, tax breaks and have been able to lower the minimum investors. competition. Very early stage firms the fact that some people just enjoy investment amounts and transaction now have more opportunity to get I was talking to a crowd investor the other making this kind of investment. costs, lower the transaction costs, the funding they need to launch via day who had put money into Just Park. He reduce the time and effort required crowdfunding. Yes, many will fail, was well aware that he was taking a punt, to source and select opportunities but there will also be a bigger pool but as he said to me. ‘I have made £1,000 and cut out expensive fund managers of survivors - who now have proof of renting out my front drive via Just Park. It and intermediaries - all of which have concept and some track record – for did not seem unreasonable to invest £100 opened up the asset class to ordinary venture capitalists to invest in. We think in its shares.’ He likes the company. In all retail investors. There is an argument a far-sighted venture capitalist industry likelihood, over time he will make several over whether giving ordinary folks such would support the development of the £1,000s more by renting out his drive. In easy access to such risky investments is crowdfunding industry, but we will have fact if Just Park can raise more money to a good thing, but we are in favour of the to wait and see if that does come to pass. principle - why shouldn’t retail investors do more marketing, he may even make have access to these opportunities? more money as increasing numbers of

18 19 “ISAs should be a good fit for alternative finance, and why should ISA investors just be limited to ALTERNATIVE FINANCE 2015 the public markets?"

Having set out the basic investment The FCA felt that equity crowdfunding Firms displaying “insufficient is that the FCA got the balance between markets? The uncorrelated, lower-risk- case for alternative finance models, was much more risky and therefore information in promotions about the protecting consumers and allowing ISAs than-equities and higher-yields-than- now we can delve a little deeper into proposed that firms offering such taxation of investments” innovation just about right. None of the cash-and-bonds promised by peer- some of the pertinent developments investments on crowdfunding platforms platforms have gone out of business CASH STOCKS to-peer lending fit well within ISAs (as The FCA is particularly concerned in the sector. Some of these are more (or using other media) promote only to because they can’t comply with the ISAs & SHARES would debt instruments). given that 62% of equity crowdfunding meaningful than others (we’ll tackle certain types of investor. These are: regulations (or at least, not yet. At the ISAs investors surveyed by NESTA and the The government seems to agree and the them in what we believe is their order moment the platforms are operating Professional clients University of Cambridge (Nesta 2014) new Innovative Finance ISA (“IFISA”) will of importance), but taken together on interim permissions. A handful of described themselves as retail investors 50% 50% be available from 6th April 2016. It will we think they are a sign of a maturing Retail clients who are advised commentators think some of them may with no previous investment experience be a separate ISA from the conventional industry. fall foul of the regulations when they Retail clients classified as corporate of early stage or venture capital ISA that holds cash and stocks and move to full authorisation. More on that finance contacts or venture capital investment. It feels it is imperative “that shares. This is something that both in later sections). REGULATION contacts firms provide investors with appropriate the alternative finance industry and The FCA set its rules for regulating the The FCA plans a full post- the ISA industry lobbied for: primarily Retail clients certified as information, in a comprehensive form, £500bn sector in April 2014 (in PS14/4, which implementation review of the to permit the implementation of sophisticated or high net worth so that they are reasonably able to can of course be downloaded from their understand the nature and risks of the alternative finance market and their money. If peer-to-peer lenders appropriate regulation and controls website), and the UK Crowdfunding Retail clients who confirm that they investment and, consequently, to make regulatory framework in 2016. can capture just a small percent of the over transferability and liquidity in Association (UKCFA) provided a good will not invest more than 10% of their investment decisions on an informed ISA market share, it could make a big ways that do not impact the existing ISA In a related issue, the FCA also summary of what is and is not regulated net investible assets in these products basis”. We think the big deal here is difference to their volumes. regime. The Tax Incentivised Savings published its guidance on the use in the chart below. the headline rates of return that some Industry (TISA) was also concerned that In addition, where no advice was of social media by financial services However, we think that the alternative platforms advertise - these are not allowing peer-to-peer lending in existing The paper is short enough to read provided firms have to carry out an firms. Of course as online businesses finance platforms need to give this investors’ likely rates of return, they ISAs could lead to a rise in reporting and quickly, but in summary the FCA appropriateness test. alternative finance platforms are big careful consideration. This is not the are the best achievable. They’re based compliance costs. Research by the Peer- proposed that peer-to-peer platforms users of social media. Going into the same game as tempting early adopter In addition, in February 2016 the FCA on less-than-realistic default rates and to-Peer Finance Association (P2PFA) came under the existing regime of core full guidance is beyond the scope of consumers to dabble online, or talking published a review into the regulation calculated before charges and tax. found that the idea of a separate ISA FCA provisions including conduct of this report, but in short firms cannot to institutions that are big enough and of the crowdfunding industry and had strong support among investors: business rules (in particular, around treat social media differently to their ugly enough to look after themselves. highlighted issues including: However, the alternative finance disclosure and promotions), minimum industry has broadly welcomed communications in traditional media - a Cash ISAs are a safe asset class backed 74% like the idea of keeping peer-to- capital requirements, client money Firms “cherry-picking” information regulation - indeed, it actively lobbied challenge when tweeting! Once again, by the FSCS. Tempting people away peer lending in a separate lending ISA protection rules, dispute resolution displayed to investors, which could lead to for it - recognising that it would be a the FCA’s report is available on its from them and into an unproven asset 81% agree that peer-to-peer lending rules and a requirement for firms to “potentially misleading or unrealistically milestone that signalled a maturing website. class that is not backed by the FSCS has different characteristics to take reasonable steps to ensure existing optimistic impression of the investment” industry and would give more could be a dangerous path to go down. investments in a Stocks and Shares ISA loans continue to be administered if the confidence to potential investors. The Platforms “downplaying” certain ISAs Of course, we’re not saying that there firm goes out of business. consensus view from both within the 81% agree that a lending ISA will important information such as risk ISA acceptance is number two on our isn’t a case for some investors making industry and from external observers introduce a greater breadth of choice to warnings list of developments. In the second their money work harder for them the investments market budget in July 2015, the government by switching from cash to alternative finally responded to the consultation on finance, but there is a large class of If the third ISA type is introduced by THE ALTERNATIVE FINANCE REGULATORY ECOSYSTEM making peer-to-peer loans ISA eligible ISA investors who are very risk averse the government, 62% of respondents REWARDS DEBT EQUITY and outlined how peer-to-peer in ISAs is and have very little capacity for will definitely invest in the product going to happen. loss - tempting them into something However, we should sound a couple of Invoice financing Peer-to-peer lending Debt securities unsuitable won’t do the alternative ISAs hold out the prospect of a very notes of caution. We know from some finance industry any favours in the long Individuals give P2C P2B Individuals buy big prize - it’s estimated that there is on and off-the record conversations run. NESTA found that 44% of those money in return Individuals buy Individuals buy a shares in early £500bn in ISAs, split 50/50 between with providers and consultants that are for a reward, invoices at a Individuals lend Individuals security, normally stage businesses who had invested in crowdfunding and money to other lend money to Cash and Stocks and Shares ISAs. working with them, that the alternative recognition, discount, then sell a form of bond, to for capital growth 64% of those who had invested in peer- individuals to earn businesses to earn They’re a mass market product with a finance platforms are not up to speed product or service them back to firms earn interest and or dividends to-peer lending had invested money at a profit interest and their interest and their their capital back much broader client base than SIPPs with the administration issues that that had been set aside for savings. This capital back capital back - they’re used by both the young and come with ISA acceptance. These centre kind of stat will frighten the regulator, old, the rich and poor, sophisticated around liquidity (retail investors should A regulated which has consumer protection as its A regulated activity and unsophisticated investors. They’re be able to get their hands on their money No financial return These fall under the new regulated activity the highest priority. Not regulated by the FCA includes in used to save for a rainy day, save for swiftly, should their circumstances so not regulated activity of operating an electronic system FCA includes in the FCA investment based a deposit on a house, to accumulate Putting these considerations to one side change), reporting and disclosure (to by the FCA in relation to lending investment based crowdfunding crowdfunding wealth aggressively, to preserve wealth though, ISAs should be a good fit for HMRC). We don’t think these are going to defensively, they’re used because alternative finance, and why should ISA be show-stoppers, as the government people don’t know where else to save investors just be limited to the public is proposing to modify some of the ISA The FCA separates alternative finance into loan based crowdfunding and investment based crowdfunding

Source: P2PFA, Alt Fi Data, University of Cambridge (2015)

20 21 “For those new to the sector it can be an extremely confusing picture, but it is important to “Peer-to-peer lending is forecast to continue to grow rapidly as an asset class in the UK as people understand the issues that need to be considered and then either do your homework or find a fund search for investments that give a decent yield with a relatively low level of risk" that can do it for you" Geoff Miller, GLI Finance John Goodall, Landbay rules to accommodate the peer-to-peer Two big changes to the way income INSTITUTIONS ARE WHAT’S WRONG WITH lending model, but perhaps some of SUMMARY ON INCLUDING PEER-TO-PEER LOANS TO ISAs from alternative finance investments is DEPLOYING CAPITAL EQUITY CROWDFUNDING? the platforms are going to find turning In short, the key policy design elect to have this authorisation taxed will be implemented in April 2016. Institutions are obviously coming into Well, absolutely nothing. It’s an asset themselves into ISA managers a bigger decisions that the government made automatically conferred upon them. Firstly, we will benefit from a tax-free the sector in search of returns for their class that makes perfect sense for the task than they anticipated. in response to the consultation are to: The FCA has not chosen to Personal Savings Allowance of £1,000 investors. In peer-to-peer lending they right investors, but it hasn’t featured It’s also possible that the platforms • Create a third ISA (the Innovative include peer-to-peer lending (or £500 for higher rate taxpayers) see a new asset class (or perhaps more very much in the discussion on SIPPs have over-estimated the size of the Finance ISA) to accommodate peer- platforms within the scope of the on the interest earned on savings. accurately, a new way to access an asset and ISAs for one principal reason: small prize on offer. Although there is a lot to-peer loans FSCS. Both the FCA and the The Treasury estimates that this will class that was previously intermediated unquoted shares already have their own of money in ISAs, there’s no reason to government think it is important for benefit 95% of people. Given that the by banks) that can provide high yield, regime of tax reliefs - the Enterprise • Modify existing ISA rules regarding expect that a huge share of it is going the regulatory framework for average lending portfolio is £5,606 low(er) volatility and predictable Investment Scheme (EIS) and Seed legal ownership of investments for to come rushing into the peer-to-peer peer-to-peer platforms to be and the average interest rate is 8.8% returns. Essentially, they’re looking Enterprise Investment Scheme (SEIS). the Innovative Finance ISA, in order lending sector. Many ISA purchases are proportionate and the FCA does not (University of Cambridge, November for better risk-rated returns than they to accommodate the established Recognising the additional risk of equity advised, and there are big barriers to consider that this is necessary at this 2014), this new allowance is perhaps think they can find elsewhere. If they peer-to-peer operating model investments into smaller companies, the advisers recommending peer-to-peer: time. The FCA is committed to more significant than the more-talked can utilise their resources and expertise EIS/SEIS regime has generous tax reliefs they struggle to understand the whole- • Adapt ISA rules regarding reviewing the regulatory framework about ISA acceptance. (Note that this to develop an understanding of the to encourage investment. These include of-the-market and make informed withdrawals and transferability for in 2016 and at that stage it will allowance does not apply to income market, institutions may be well placed up-front income tax relief, CGT deferral, decisions; they are concerned about the Innovative Finance ISA, so that consider again whether peer-to-peer from shares or funds). to take advantage of the transparency no tax on gains made within an EIS and regulatory risk; it can be difficult to these only apply to cash held in an should be within the remit of the and low costs that peer-to-peer Second, investors will be able to offset IHT relief (via BPR). With these reliefs remunerate themselves when investing Innovative Finance ISA FSCS. platforms provide. losses from failed loans against other on offer, there is no benefit to making their clients in this sector. We hope that The government has confirmed Nearly all peer-to-peer platforms peer-to-peer income for tax purposes, It’s not possible to determine exactly investments in equity crowdfunding via this new ISA doesn’t go the way of the its intention to use the proposed (15 of 17) who responded said that and will be able to apply for this relief how much money institutions are an ISA (where EIS/SEIS benefits would long-forgotten Insurance ISA, which was definition of “relevant agreements” they would consider seeking on losses incurred from April 2015. deploying via the platforms, but AltFi be lost). The equity crowdfunding launched and sank without a trace. in article 36H of the Financial authorisation to act as an ISA This puts the platforms on an equal Data has a good proxy: the number of platforms have been utilising the EIS/ That seems unlikely though. This is Services and Markets Act 2000 manager if the government were to footing with the high street banks, whole loans that are funded. To make SEIS regime right from their inception. a big milestone for the peer-to-peer (Regulated Activities) Order 2001 as permit this. Platforms that but the benefit to the platform will them more attractive to institutional However, the government has announced lending industry - there is no doubt a general basis for identifying responded to say that they wouldn’t depend upon the model they employ investors, some of the platforms are that it will consult on including debt that being able to access this new asset peer-to-peer loans that will be seek to apply for ISA manager status - platforms with contingency funds now allowing investors to purchase a securities (mini-bonds and debentures) class through ISAs will be huge boon for eligible for ISA inclusion. stated that they would look to already repay investors' capital when whole loan as opposed to a fraction of a and equity crowdfunding options peer-to-peer lending over the long term. outsource this role to a third party. they suffer defaults and so in theory loan. With their larger capital reserves The government will proceed with in ISAs. We think that certain debt But it might take longer and have less there are no losses to offset. and ability to assess the risk of whole its proposal to make advising on peer- securities would be an excellent fit. impact than expected. As mentioned on loan opportunities, it’s a reasonably to-peer loans a regulated activity. All In addition, depending on the outcome the next page, the new Personal Savings safe assumption that whole loans are However, as it stands at the moment, firms currently authorised to advise The full document can be found on of a consultation, the government will Allowance and bad debt relief for peer- bought by institutions and fractional unquoted shares (with the exception on investments will be eligible to www.gov.uk probably also introduce a withholding to-peer lending income is possibly more loans by retail investors. of AIM and ISDX shares), debentures tax regime from April 2017, meaning significant right now, and takes away and mini-bonds (the three securities that tax on income will be deducted AltFi Data has analysed this for one some of the urgency around the ISA that crowdfunding platforms offer) at source, so investors will no longer of the biggest peer-to-peer business issue for most peer-to-peer investors. outside of the government consultation money to their borrowers. Investors are not allowable in ISAs. They are all need to complete a self-assessment tax lenders, Funding Circle. and industry-level work taking place to do not have direct exposure to the technically allowable in SIPPs, subject to return, again bringing things in line OTHER WAYS TO GET PEER-TO-PEER get alternative finance into ISAs. underlying loans as they would with the SIPP operator accepting them and with bank deposits. LENDING IN AN ISSA conventional P2P lending. If Wellesley Wellesley Listed Bond. In May 2015, being satisfied that they will not breach goes bust, investors lose - they are However, all of this applies to direct peer-to-peer lender Wellesley & Co. the rules around taxable property, not contracted with the underlying peer-to-peer lending. We must not issued an ISA eligible retail bond listed on unauthorised payments and trading. borrowers. forget that there are a number of the Irish Stock Exchange. The funds raised (2015) closed funds listed on the London will be used to invest in asset backed SyndicateRoom. SyndicateRoom has WHOLE LOANS ORIGINATED BY FUNDING CIRCLE Stock Exchange that invest in peer- loans and the bond pays fixed rates of begun raising money for companies 40 Whole loans to-peer lending and are ISA eligible return over a three or five year term. listed on the ISDX. These shares are ISA 35 from July 1st 2015. The innovators who qualifying, so this goes down as the first Fractional loans Structuring the product in this way 30 set these up and the Association of equity crowdfunding that is ISA eligible. % Whole loans meant that Wellesley could give 25 Investment Companies who lobbied for However, the EIS/SEIS tax regime is investors exposure to peer-to-peer 20 ISA acceptance for these trusts deserve far more attractive than ISAs when lending via an ISA, regardless of 15 credit here. (We’ve got more to say investing in smaller companies, so this the outcome of the consultation. 10 about these trusts below.)

is a bit of a moot point (that Syndicate (£m) volume Lending However, it does alter the nature of the 5 Room are the first to acknowledge). Finally, there have been some other exposure: investors are lending money 0 innovations that have taken place to Wellesley, who will then lend that TAXATION OF RETURNS Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr FROM P2P LENDING 2014 Whole loans can be used as a proxy for institutional investment on lending platforms Source: Alt Fi Data

22 23 “Institutions are obviously coming into the sector in search of returns for their investors. LARI Absolute return 1.61% +0.01 5.45% +0.05 18% -0.03 PERFORMANCE Change In peer-to-peer lending they see a new asset class that can provide high yield, low(er) volatility (as at 30 Sept 2015) 1 YEAR 3 YEAR and predictable returns." MONTH3

Obviously this is just a snapshot of interface) provided by the platforms to CEO and founder of Numis said. “This of automatic diversification across as of June 2015) a proxy on a single platform, but % OF INSTITUTIONAL FUNDING ( access loan data and then an algorithm investment in Crowdcube will put Numis loans and platforms and professional we think it is still an indication of an to invest in loans that fit the investment at the centre of the entire investment management of your money. On the industry-wide trend. Interestingly, AltFi objectives. At the moment they are only chain, from initial start-up capital all the other hand, they come at cost and - for Data speculates that the falling off of working with Prosper and Lending Club way to IPO”. now at least - it’s difficult to judge if whole loans since March 2015 could be - the two big players in the US market - the cost is good value or not. There What we’re seeing here is a blurring of because Funding Circle is actively trying 0.01% 30% 0% but this could be an indication of where are currently no benchmarks being institutionally funded. institutionally institutionally funded, but the distinctions between traditional to control the influx of institutional P2P is heading in the future. The group employed to measure them against, Ecology Building Society funded with the expectation of fund raising and crowdfunding, and capital into its marketplace to achieve a hitting 80% institutionally also floated its Ranger Direct Lending although the The Liberum AltFi Returns accounting for only 3.7% crowdfunding investors can expect to balance with the more steadily growing of total funds raised funded by the end of Fund (RDL) on the London Stock Index would make a good benchmark 2015 – owing to a secured get access to a much broader range of retail investor base. Exchange in May raising £135 million. as it replicates the investor return £250m bank credit line opportunities from much more mature across a fully diversified portfolio AltFi Data has also analysed this P2P Global Investments (P2P:LON) companies than those that have been within the peer-to-peer lending sector. phenomenon on Zopa and Ratesetter – listed on the 30th May 2014 after raising available to date. Another stumbling block is that not the details are available on its site in an £200 million. It’s managed by hedge all platforms report the performance article entitled “Is P2P Lending a Thing fund firms Marshall Wallace and WHO'S BEEN INVESTING of their loan books or their passive of the Past?” Eaglewood Capital Management To date, it has mostly been city investment products consistently – (another peer-to-peer specialist) and We also have some rough, estimated institutions investing in these funds. although the P2PFA is working hard to 70% 45% 30% buys loans from the likes of Funding data from some of the platforms institutionally institutional, in 2015 and between address that. Finally, it’s worth noting funded 55% high net worth 10% and 15% all time Circle, Zopa and RateSetter. They Perhaps the most prominent example themselves, courtesy of AltFi. that the financial consultancy firm declared a dividend of 16.5p per share has been the £20 million investment Altus (among others) has stated that Looking in more depth at the emergence in May and at the time of writing the by the highly rated fund manager Neil it believes the cost of intermediation, of dedicated retail funds and investment share price performance has been Woodford made into RateSetter in March such as management fees is likely to firms, GLI Finance, Victory Park Capital, Source: Alt Fi, as of June 2015 positive. So far they are delivering what 2015, alongside Artemis, the big name be offset by P2P platforms lowering Shepherd Capital and P2P Global Obviously their intention is to see Shepherd Capital have been it says on the tin - in fact at the time of fund manager with the long running fees. Their feeling is that intermediation Investments and are the most prominent the value of their equity investments investing in the peer-to-peer space writing they were trading at a premium “profit hunter” advertising campaign. through funds is essential if the peer- examples to date. It’s worth taking a increase and make a return on the since 2010 in both the US and the UK to their NAV (as are the other funds). We’ve also seen investments by F&C, to-peer lending sector is to reach its full closer look at these first-movers. (Note loans they have invested in at the same and recently teamed up with Eiffel Invesco Perpetual, Aviva Investors, And finally, at the time of going to potential. that all of the funds are closed funds.) time. Their equity stakes give them Jupiter Asset Management, City Financial Investment Group to launch Eiffel press, Funding Circle has also stated its ongoing insight into the businesses that and Axa Investment Managers (Source: For retail financial services professionals GLI Finance (GLIF.L) went through a eCapital. The new joint venture will intention to float its own fund on the are originating the deals that they are Bloomberg). However, like much of the though - advisers, SIPP operators, business rethink and specifically invest across a number of different stockmarket that will invest in loans on investing, and confidence in the way news flow in alternative finance, there ISA providers - these funds are retail identified the funding gap - the inability niches within the alternative finance it UK and US platforms. they are being managed. They have is no need to get too excited - these investment products that will be much or reluctance of the banks to lend to spectrum, including consumer peer-to- created a "head of lending" role that As for crowdfunding, rather than are really significant milestones, but easier for them to understand, accept SMEs - as an opportunity and have now peer loans through to more specialist has oversight over all of their lending institutions deploying capital the more the fund managers are only investing and recommend to their clients. With reconfigured their activities to reflect small and medium sized business activity and they have invested in 19 exciting development is seeing the tiny percentages of their portfolio into investment trusts on a bit of an upward that (they previously specialised in funding. This venture is noteworthy for strategic partners (at the time of writing platforms used to raise funds alongside P2P: according to the FT, at the end of curve after the Retail Distribution Review Collateralised Loan Obligations, so the the background of the players involved: - don’t be surprised if they make more traditional City brokerages. Sandal is a March Neil Woodford’s investments levelled out the playing field for trusts move into alternative finance is a logical Shepherd Capital is a Luxembourg investments) across eight different listed firm that used SyndicateRoom’s into peer-to-peer comprised 1.46% and OEICS, we expect these sorts of step). They have now built a business based family office (managing the assets alternative finance sectors in North platform to issue shares to the public, of his Woodford Equity Income Fund. funds to play their part in taking peer-to- model based on both making equity of the founder of the Yves Saint Laurent America, the UK and Europe - so they and Crowdcube has secured an Are these funds good investments for peer lending to the mass market. investments into the platforms fashion empire) and Eiffel Investment have a well-diversified investment in the investment from Numis, a specialist in retail investors? It’s hard to say. On themselves, and investing into the debt Group is a French fund manager with industry. smaller company IPOs. Oliver Hemsley, the one hand they offer the prospect the platforms originate. They work very €250 million AUM. It demonstrates the appeal to other investors such as family closely with their investee companies Victory Park Capital’s Specialty offices and the increasingly cross- (2006-2015) (“strategic partners”) giving them board Lending Investments (VSL.L) PERFORMANCE OF DISRUPTERS THE LIBERUM ALTFI RETURNS INDEX level advice and help on core activities border nature of institutional successfully floated on the London The performance of some of these 6.5% such as compliance, risk management involvement in alternative finance. Stock Exchange in March 2015 raising listed vehicles (and many more) is and credit underwriting, as well helping 6.0% £200 million. Much like GLI, it will be Ranger Capital Group is a US captured in the LAFDI (Liberum AltFi them with sales and marketing and the investing directly in both the debt (and investment manager that has launched Data Disrupters Index), a “Float Market benefit of their network of contacts. 5.5% trade receivables) originated by the a specialist fund to invest in loans Cap and Liquidity rank weighted index They also lobby on behalf of the platforms and in the equity of the originated by peer-to-peer lending comprised of a selection of companies alternative finance industry - for 5.0% platforms themselves. Bear in mind that platforms. What’s interesting about this that are disrupting incumbent banks example they had a lot of input into the the big US peer-to-peer lender, Lending proposition is that it makes explicit just and financial services companies by legislation which mandated UK banks to 4.5% Club, was valued at $5.4 billion for its how they intend to outperform - by adopting a radically new approach”. refer business they could not write onto IPO in 2014 - these equity stakes could using an API (application programme other neutral finance options. prove to be very lucrative. 4% 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: Alt Fi.com

24 24 25 "The sector has been built on the back of retail investors who were either looking for a better deal SIPP £40,000 £1,25m 25% 0% BENEFITS ANNUAL LIFETIME % TAX FREE % CGT or wanted to disintermediate the financial services sector (or both)" (2015 / 2016) LIMIT LIMIT LUMP SUM

Taxable property consists of Meeting the rules for SIPP acceptance interest in alternative finance. GOLDMAN SACHS ANALYSIS OF THE ALTERNATIVE LENDING IN THE US (2015) residential property (including is only half of the picture though. The The remainder are 430,000 restricted Total % inside Amount % in banking Amount at Tot. banking Select Market Competitive residential ground rents, timeshare/ SIPP operators themselves will only Type market banking in banking system at banks at risk profit pool disruptors / choice SIPPs with £30 billion in assets size type advantage? holiday homes and the grounds of accept alternative finance investments size system system risk of leaving of leaving at risk new entrants and 500,000 platform SIPPs with £50 residential properties) and tangible if it makes commercial sense for them, Lower capital billion in assets. There’s no reason why Unsecured personal Lending club, moveable property - this includes art, and that decision might come down to $843bn Loans O/S 81% $683bn 31% $209bn $4.6bn requirement, these cohorts wouldn’t eventually also lending Prosper antiques, fine wine and vintage cars. In the issue of whether the investment is technology invest in alternative finance, but at the effect, anything that one can touch and classified as a non-standard asset or not. Technology volume end of the market the processes OnDeck, Small business loans $186bn Loans O/S 95% $177bn 100% $177bn $1.6bn (drives time, move potentially falls into the tangible Kabbage After seeing a lot of investment into will need to be quick, clean and simple moveable property category. In addition convenience) esoteric assets via SIPPs (much of which to keep costs down. Alternative the scheme member and connected Leveraged lending $832bn Loans O/S 7% $57bn 34% $19bn $0.9bn Regulatory the FSA/FCA considered was inappropiate parties must not derive any personal Our guess is that some of the bigger AM, BDCs for the investor), the FSA/FCA took several providers at this end of the SIPP market Regulatory, use or enjoyment from the property. SoFi, Earnest, steps to clamp down on this sort of Student $1,222bn Loans O/S 5% $65bn 100% $65bn $0.7bn technology, will negotiate preferential terms with CommonBond Alternative Finance Investments are activity and protect unwary consumers. convenience product providers (something they unlikely to fall foul of this rule unless the Annual Quicken, PFSI, Regulatory, One of the tangible outcomes has been are used to doing in the world of Mortgage origination $1,169bn 58% $678bn 100% $678bn $2.1bn loans were used to fund a purchase of volume Freedom convenience higher capital adequacy requirements mainstream investments) or perhaps taxable property. This could potentially OCN, NSM, Regulatory, for SIPPs holding non-standard assets. even create their own alternative finance Mortgage servicing $6,589bn Loans O/S 73% $4,810bn 6% $300bn %0.1bn trigger a tax charge. It also precludes WAC costs Non-standard assets are defined in platforms. We wouldn’t be surprised to any payments in kind or ‘rewards’ for an Comm. Regulatory, the negative, i.e., anything that is not see some white labelled products pop up investment (these would be considered CRE $2,354bn Loans O/S 56% $1,322bn 9% $118bn $0.8nb mREITS, alt. market a standard asset "Standard assets here. Hargreaves Lansdown are among personal use). lenders dislocation must be capable of being accurately a few already making moves in this and fairly valued on an ongoing basis, direction. Total $13,195bn 59% $7,792bn 20% $1,566bn $10.9bn Unauthorised Payments is a biggie for alternative finance in SIPPs. The rule readily realised whenever required (up Furthermore, in the light of the new is there to prevent SIPP investors to a maximum of 30 days), and for an Goldman Sachs believe that there is $11 billion of profit that alternative lenders can capture in the US Source: Goldman Sachs pension freedoms, Moret has predicted making payments to "connected amount that can be reconciled with the that the SIPP industry could grow to parties" and liberating cash from their previous valuation" (FSA Consultation As an asset class, alternative finance is mentioned that they can leverage their are now institution-to-peer as much as 2 million SIPPs with £300 billion in pension tax free ("pension liberation"). Paper CP12/33). obviously keen to secure inflows from resources and skills to take advantage ‘peer-to-peer’ now. The most nuanced assets by 2017. If the alternative finance In most scenarios, a loan cannot be institutional investment. It’s a huge pool of the transparency in the P2P sector. view of the nomenclature is: If alternative finance platforms don’t meet platforms can crack it, this is a big made to a connected party without of capital that can give the industry We know that institutions have more these criteria, then any SIPP operators market. Peer-to-peer lending: consumers incurring tax charges, but P2P lending the scale it wants (on the supply side capacity to invest in whole loans. The they work with will have to meet the higher and institutions are the lenders would make it fairly easy to circumvent In summary: alternative finance is finding at least), provide liquidity and hold the fear is that they can cherry pick the best capital adequacy requirements - another the rules. Andy Leggett of Barnett its way into SIPPs already: Abundance platforms up to ever higher standards. investment opportunities, leaving retail Marketplace lending: institutions hurdle the platforms have to overcome. Generation, Assetz, Mayfair Bridging, And there is no doubt that institutional investors to choose from less attractive are the lenders Waddingham calls this "buddy loans": investment is also a stamp of approval opportunities. A more intangible outcome after the Proplend, RateSetter, Rebuilding Society, platform is that shows a maturing sector. And if the Balance sheet lending: "BUDDY LOANS" regulator’s intervention is a very wary ThinCats, Zopa and Wellesley & Co have One view on this is that it should be up the lender funding gap is to be closed for SMEs, it SIPP industry. It seems that the FCA all secured acceptance with some SIPP to the platforms to manage this and expects SIPP operators to play their operators and there’s no doubt that the will require institutional money - of that In summary: institutional funding is vital communicate it to their retail investors. part in consumer protection. This investment case for alternative finance there is no doubt. if the platforms are going to address the means more thorough due diligence on also makes sense within a SIPP, but there Another view (unsurprisingly, from the funding gap, and the rigour institutional investments made via a SIPP and checks are technical and commercial barriers to A DOWNSIDE? institutions themselves) is that it is up investors bring to the sector should on appropriateness and suitability, overcome to make this work on a bigger However, it does raise a concern to the investors and their advisers to do benefit retail investors as well. However, again raising costs for the operators. scale. that alternative finance will lose its their due diligence and ascertain if their the funds must look at each individual SIPPs prevent connected parties make innocence somewhat. The sector has chosen platform is giving an edge to platforms’ credit, risk and compliance loans to one another without incurring So why should the platforms bother We think that the more sophisticated been built on the back of retail investors institutional investors. Our view is that procedures if they are going to be tax charges chasing SIPP acceptance? Quite simply, nature of a SIPP and SIPP investors (at who were either looking for a better it’s fine to push this responsibility onto successful over the long term. Just using there is a lot of money in SIPPs. least in theory) means that both equity deal or wanted to disintermediate the the investors/advisers - provided, and their scale to snap up loans still leaves Trading. This rule is there to ensure crowdfunding and peer-to-peer lending According to John Moret of MoretoSIPPs financial services sector (or both). only provided, that it is made very clear them exposed to some big risks. that there is no advantage to running a would work within a SIPP, but we suspect to them what advantages are afforded consultancy, currently there are It felt like a much fairer and a much more business within a pension. Alternative more investors will be tempted by the to institutions. We don’t believe that this approximately 1.2 million SIPPs in the democratic way of investing money. Now SIPP ACCEPTANCE finance investments are unlikely to fall uncorrelated, lower risk, high yield is the case at the moment. UK with £150 billion in assets. Of these, Alternative finance investments are SIPP foul of this provision. nature of peer-to-peer (and other debt the sector would claim - with justification 270,000 of them are full choice SIPPs acceptable provided they meet the rules instruments such as debentures) rather - that is still the case. But the big concern As we noted earlier, the term peer-to- For more information on what is and is controlling £70 billion in assets and logic around taxable property, unauthorised than the high risk/return profile of is that institutional investors and funds peer seems to be fading out of fashion, not allowable in a SIPP, go to would suggest that these operators and payments and trading. If they do not unquoted equity. that control large pools of money will be and (the more institutional sounding) www.in-review.com their investors will be the first to take an able to get a better deal than individual marketplace lending is replacing it, meet the rules, they will be subject to a retail investors can. We’ve already perhaps reflecting that many platforms tax charge.

26 27 “The UK government has supported the development of alternative finance since its inception “Sure, raising equity and lending money is nothing new, but doing it so quickly, so transparently and naturally has an interest in how the peer-to-peer sector can support SMEs who are so vital and at such a low cost online is a significant change and a challenge to the existing models." to the UK economy"

One final point. It’s estimated that 80% of a key to the future success of the small and comparing investments across Scotland and Assetz and Metro Bank and Liberum and AltFi Data have CONCLUSIONS SIPPs are advised (Source: MoretoSIPPs), business sector, 48% thought that it Zopa are all good examples. We should worked together to produce a number platforms less daunting, and also opens Sure, raising equity and lending money so working with financial advisers might would make funding more expensive be clear about the points we’re making of indices that measure the growth in up the industry to greater transparency. is nothing new, but doing it so quickly, be the key for the alternative finance for businesses.) here – the mandatory referral scheme is volume and the returns of the CrowdWatch also operates in the US so transparently and at such a low cost platforms here. a good indication of the Government’s alternative finance sector In addition, the UK Government-backed with some of the largest US platforms online is a significant change and a direction of travel, but the banks have London Co-Investment Fund (LCIF) is Liberum AltFi Volume Index UK is and their data is already being used in challenge to the existing models. Taken independently come to the conclusion MANDATORY REFERRAL set to invest £5million in London’s finest the market leading peer-to-peer index, indices, such as the CNBC Crowdfinance together, we think that all of these that they need to work with the peer- SCHEME, BRITISH BUSINESS seed-stage technology, digital and tracking the growth of the UK industry Index, tracking the 50 largest capital developments paint a very clear picture to-peer lending sector. Both of these BANK AND GOVERNMENT science businesses through Crowdcube. from inception. The index is updated commitment by private US companies of an asset class that is rapidly maturing. demonstrate that peer-to-peer lending SUPPORT The investment pot is earmarked for daily and users can use interactive listed on CrowdWatch’s platform. must be taken seriously. A few years ago it, while it was an The UK government has supported the high-growth firms making the transition graphs and charts to explore the Ratings and reviews are part of unregulated activity undertaken by development of alternative finance from start-up to growth phase and evolution of the industry. A similar index mainstream fund based investments a few brave or foolhardy souls who since its inception and naturally has typically for companies looking to raise MEANINGFUL MARKET DATA measuring the European peer-to-peer and an essential resource for many stumbled across the platforms online, an interest in how the peer-to-peer between £250,000 and £1million. Anything which increases the visibility industry is also available. investors. They are starting to become it could be easily ignored. But in a very sector can support SMEs who are and transparency of a market should And to be fair to the banking sector, Liberum AltFi Financial Disruptors part of the alternative finance world as short space of time it has grown in so vital to the UK economy. The two enhance its appeal to investors and some of them have made tie-ups with Index measures the performance of well. scale, attracted institutional investors, major planks of government support we’ve seen developments in this area the lending platforms outside of the listed companies who are considered to been brought under the FCA’s umbrella, have been the deployment of funds with new indices, reviews and service On the ratings side, in July 2014 research mandatory referral scheme: Santander be disrupting incumbent banks and started to produce meaningful data on through alternative finance providers companies entering the market. agency FE gave the RateSetter platform and Funding Circle, Royal Bank of financial services companies with their risk and returns, is on the verge of being via the British Business Bank and the a cash-like risk rating of 1, based upon business model and approach. (More accepted into the nation’s most popular mandatory referral scheme for high the low levels of volatility the platform’s information at www.altfi.com/data) investment wrapper and turned itself street banks. THE LIBERUM ALTFI VOLUME INDEX UK ) (2005-2015) investors have experienced to date. into a conduit for the government to Cumulative volume There is also another index, provided In June 2015, ARC Ratings awarded The British Business Bank provides supply credit to SMEs. That’s a pretty £4bn by 4th way (www.4thway.co.uk). This is alternative mortgage lender LendInvest finance to smaller businesses by impressive track record. £3.6bn a less rigorous, forward looking index a rating of SQ1, which is the highest deploying its funds through partner £3.2bn that is based on the interest rates that rating the company has, based upon intermediaries - which now include £2.8bn the platforms expect ordinary lenders the platform’s ability to originate deal KEY FINDINGS alternative finance platforms. To date £2.4bn to achieve, on average, after fees and flow and its underwriting and servicing the bank has already issued over The FCA is particularly concerned £2bn forecast bad debts, if they spread capabilities. £200million of awards to the alternative that 62% of equity crowdfunding £1.6bn their money equally between the finance space, the recipients being On the review side, All Street is a investors surveyed described £1.2bn constituents. Each lending platform has Zopa, RateSetter, Funding Circle, new entrant proposing to provide themselves as retail investors with £800m a slightly different way of calculating this MarketInvoice and Urica. Back in 2012 individual investment reviews of no previous investment experience £400m number, so while the index may give a when this initiative really got started, equity crowdfunding opportunities in early state or VC investment 0m good indication of possible returns, it the previous Business Secretary 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 for retail investors. SIPP Investment The Innovative Finance ISA will can only ever be a broad approximation. Vince Cable said in a statement: “As Platform (now trading as in:review) accept peer-to-peer lending and Source: AltFi.com businesses are continuing to struggle to Liberum AltFi Volume Index P2P Business Lenders AltFi also provides extensive news also developed a peer-to-peer platform launch in April 2016 P2P Consumer Lenders Crowdfunding get credit from their banks, developing coverage and analysis of the sector on review service in 2014, with a 70+ Investors have been able to offset alternative lending channels is essential its website and hosts alternative finance question DDQ covering seven key losses from failed loans against other so firms are less reliant on banks. Our research seminars, events and awards, aspects of peer-to-peer platforms. The peer-to-peer income for tax THE LIBERUM ALTFI RETURNS INDEX (2006-2015) aim is to create a more diverse financial all of which can help interested parties objective is to help its subscriber base purposes since April 2015 infrastructure which better serves the Trailing 12 Month Return get a grip on the market. of SIPP operators and financial advisers 6.5% Institutional investors have been needs of our small and medium-sized carry out due diligence on platforms In the equity crowdfunding space increasingly interested in alternative companies.” that their clients may wish to invest in CrowdWatch powered by Crowdnetic, finance and we have seen the 6.0% via their SIPP. The mandatory referral scheme will allows users to analyse market data emergence of several large dedicated oblige ten major banks to refer on by sector, industry, security type and Finally, we know that a handful of legal funds and investment firms 5.5% businesses they turn down for credit to geography. This tool gives users the and compliance firms, PR gurus and Alternative finance investments alternative finance providers. Launching ability to view real time listings across marketing agencies are targeting the are SIPP acceptable provided they 5.0% in 2015, this initiative follows on from several large UK platforms (10 at the alternative finance space - all keen to meet the rules around taxable a deal that Funding Circle did with time of writing), tracking how much and find a role for themselves and play a property, unauthorised payments 4.5% Santander in June 2014, demonstrating when an investor chooses to commit part in this exciting new sector! and trading how such a scheme could work in capital to a company. The platform The mandatory referral scheme practice. (Although interestingly, 4% also allows users to view valuation will oblige 10 major banks to refer according to an online poll for Liberis, 2006 2007 2008 2009 2010 2011 2012 2013 2014 data by the same criteria. This type businesses they turn down for credit while 85% of SMEs think the scheme is Source: Alt Fi.com of market insight makes researching to alternative finance providers

28 28 29 RISKS OF ALT FI

Assessing and comparing the various Lower Levels of Scrutiny and Data: ways the platforms have tried to Public markets have enough money For such a new mitigate these risks adds another layer moving through them to justify extensive of complication. We’ve done our best amounts of research on the investment asset class, to set out and assess the risks for each opportunities - produced by both the working out of the different varieties of alternative buy and sell sides. Big institutional INVESTING IN ALT FI finance below, but ultimately this is just investors can afford to scrutinise the what the risks our view of the risks - there isn’t lots of markets and the underlying investments data to provide empirical evidence. Mike very carefully and there are a plethora of are is difficult. Baliman, host of the London Fintech sources of market data and information. Podcast and a consultant on the topic This scrutiny and information Or to be more of risk, wrote a series of articles in the ecosystem doesn’t exist in alternative alternative finance sector for AltFi - you finance yet (although, AlfFI, Liberum and accurate - can find them online and we’d suggest the institutional investors are starting reading them in conjunction with this to to bring it about), meaning that markets working out give a full and complete overview. are less efficient, price discovery is less what the risks The platforms have considered these transparent and poor practices have risks and have implemented different more chance of going undetected for are is pretty ways to mitigate them – something we’ll longer. examine in more detail further on. easy, but Incentives, IPOs and Chasing Volume: Lending Club, the US peer-to- quantifying BIG PICTURE RISKS peer platform that lends to both What are the big picture risks that are consumers and businesses, made its them is very common to all of the alternative finance stock market debut in December 2014 difficult. platforms? at $15 per share, valuing the company at No FSCS protection: Simple, but $5.4 billion. That’s a huge return for the important. Any investment via an founders and owners of the platform alternative finance platform will not be and it is of course something that every covered by the Financial Services other alternative finance platform will Compensation Scheme, which have noticed with more than passing compensates the first £75,000 of any interest. It’s such a massive carrot, it deposit with an institution if that could lead some platforms into chasing institution goes bust. So if a platform volume to give a short term boost to that’s holding your money goes into their revenues and achieve the sort of meltdown, that money may well be lost scale that would indicate that they are for ever - a big contrast to a bank deposit. IPO ready. Inevitably, this will mean sacrificing quality for quantity and can No Track Record: While past only really result in a worse overall performance is not a guarantee of performance for investors. This, future returns, it is a guide to help unfortunately, feels distinctly oldFi - assess the competence of somebody institutions putting their own profits who is going to invest on your behalf. A and goals before their customers. longer track record that shows success throughout the business cycle is an Frauds: To date there have been indication of competence - but as a new relatively few frauds on alternative asset class very few platforms (perhaps finance sites – and certainly none that only Zopa) can evidence this. So while have been very high profile, although lending platforms can model how they we have heard on the grapevine that a think they might perform if interest leading lending platform was rates rise or defaults increase, we have successfully targeted. There are a no empirical evidence to judge them on. handful of fraudulent companies who have targeted equity crowdfunding sites - notably Kickstarter, which is a US

30 31 “Investing in peer-to-peer is different to other forms of investing – it is very important to have a “Lender security is at the heart of everything ArchOver does, it is our primary concern” highly diversified portfolio of investments, to reinvest capital quickly which has been repaid, and Angus Dent, ArchOver to understand the impact of any lack of liquidity on risk" Stephen Findlay, BondMason

(1985-2014) THE BUSINESS CYCLE - US CORPORATE LOAN LOSS RATES CROWDFUNDED COMPANIES STILL IN BUSINESS (2011-2015) 3.0% 160 Active 140 2.5% Accounts/Annual Return Overdue 120 2.0% Administration/Dissolved 100

1.5% 80

1.0% 60 Number of projects of Number 40 0.5% 20 0.0%

Year product It’s hard to assess a peer-to-peer lending platform’s credit model if it has not been through a full cycle Source: Federal Reserve funded: 2011 2012 2013 2014 2015

87.5% 77.27% 87.76% 96.58% 97.37% rewards based site (it doesn’t really authorisation. A few commentators we loans and by carrying out some sort 0% 13.64% 8.16% 3.42% 2.63% purport to be an investment based site) have spoken with think that this means of assessment of the creditworthiness 12.5% 9.09% 4.08% 0% 0% and does little to no due diligence on there could be some real speed bumps of the borrowers. Here are two of the

the opportunities it lists. Equity ahead as some of the platforms may be platforms’ four principal activities % products crowdfunding sites are the more inadvertently structured as Alternative (the other two being origination of obvious target for any fraudsters, but Investment Funds (AIFs): investments, borrowers and lenders and servicing this is nothing unique to online risks, management of the underlying loans) and investors EITHER need to crowdfunding - dodgy equity salesmen assets and returns are all pooled and have faith in their chosen platform’s The crowdfunding industry is still young and there is not much data to assess – but so far crowdfunded companies are doing better than expected have existed as long as equity sales. therefore they are an AIF. ability to carry them out OR investors Source: AltFi Data have to have faith in their own ability We do know that peer-to-consumer There are also concerns that some of to do so - both options are available. Which brings us on nicely to… investment. But how do you value a new lender Zopa uses the AU10TIX to verify the platforms do not meet the rules issuing more shares at a later date, It’s the simplicity and low costs of business? Or how do you value a small, and therefore diluting the value of borrowers’ identities online, and that around client money, and that some are LIQUIDITY RISK the platforms that make option unquoted business that has not issued it thinks this system has already paid not following the rules around financial existing shares. This can be prevented two attractive for active investors, There are platforms that operate any shares before? This is notoriously for itself after capturing one fraudulent promotions. by securing preferential shares of some and opens up the possibility of out- secondary markets for their loans and tricky and is probably as much an art as borrower out trying to withdraw a description, or having some meaningful All of these are of course serious performance. fractions of loans where they match a science - which suggests that wisdom “sizeable” amount of cash. influence on the board and executive problems, but we feel that they are buyers and sellers. Just how deep these and experience have a role to play here. team, but again these measures are OPERATOR INSOLVENCY In May 2015 we also saw the first natural in a new and developing sector, markets are is unclear at this point in The difficulty with most crowdfunding absent from some crowdfunding models. examples of cloned websites in the P2P and that the platforms’ intentions are A real concern lies in a platform blow up time – see our survey for more on this. models is that the valuation is company EXIT RISK space. An unauthorised firm set up genuine and that any of them that are in due to undisclosed losses, or poor cost Certainly there is no centralised clearing led. They put a valuation on their zopaloanreviews.com and essentially breach of the regulations will work with control, or a failure to keep originating house for all the loans across the entire business, and then go out and see if they Early stage firms are unlikely to pay passed itself off as P2P lender Zopa. the regulator to overcome any issues. It lenders and borrowers. NESTA, sector - investors have to rely upon the can find crowdfunding investors who are out any dividends to shareholders, so The FCA moved swiftly to shut this site is an issue worth keeping an eye on over the innovation think-tank that has community on their chosen platform. A willing to invest at that valuation. This is the only way to see any kind of return down, but it is another potential scam the next few months as the platforms produced several in-depth reports on run on a platform’s loans would mean NOT what conventional venture capital on your investment is from some sort consumers and businesses must be move to full authorisation though. alternative finance in conjunction with liquidity would become non-existent funds and business angels do, where of exit - either a trade sale of the firm aware of. Again, it is not unique to the the University of Cambridge, predicted very quickly, which would suggest that the valuation is a product of negotiation. to a rival, a management buy-outs alternative finance sector, but the online PEER-TO-PEER LENDING a major platform blow up in 2015. At the bigger platforms with higher volumes Traditionally, companies raising funds now not allowable for EIS & SEIS or an nature of alternative finance perhaps RISKS time of publication there is still over a are less risky. would expect to get their valuation initial public offering on a recognised makes it more vulnerable to cloning BORROWER DEFAULT month to go. beaten down, Dragon’s Den style. This exchange. Getting a business to an exit than traditional finance firms. It’s easy missing step is seen as the biggest is no mean feat and requires luck, skill This is the biggest difference with INTEREST RATE RISK CROWDFUNDING RISKS to protect against though - check the weakness in the majority of online and good planning. There’s no liquidity putting money in the bank – the risk VALUATION financial services register or consumer Another risk that applies for any fixed equity crowdfunding platforms. to get out before the exit (or at least has been shifted from the bank to the credit interim permissions register. income investment. If interest rates rise, Of course there are many secrets to very, very little) and no income in the lender. As with all lending activities, DILUTION some longer term peer-to-peer loans successful business angel investing, meantime. Regulatory Risk: To date, the the biggest risk is that the borrower might look less attractive, and this will but surely one of the biggest is no Another big risk of being a small platforms have had a successful defaults, leaving the lender without The track record of successful exits be compounded by a lack of liquidity secret at all - you must invest at a shareholder in an unquoted company relationship with the regulator, but over their principal - a capital loss. The would be an interesting statistic for - it might be hard to exit investments sensible valuation, to give you a realistic - there is very little that can stop the the next few months they will move ways to mitigate this are well known: platforms to share with investors, but in anticipation of an interest rate rise. possibility of making a return on your company raising more money by from interim permissions to full diversification across a lot of different as the oldest platform is only four years

32 33 “Investing in commercial real estate debt offers investors attractive fixed income returns with downside capital protection, it’s the safest part of the property investment as you are the first to be repaid" Brian Bartaby, Proplend PLATFORM MELTDOWN old the data simply doesn’t exist in a .PIVOTING Another proxy to help us measure What happens in the event of a P2P able to take over the management and great detail yet. However, AltFi Data has default rate risk would be Funding TRUSTBUDDY FAILS platform meltdown? administration of the platform. “Pivoting” is using investors’ money attempted an analysis, based upon cross Circle’s stress testing exercise. They Although this report is focused on for something other than the original “So your clients are asking you how to This can be achieved by the peer- referencing the successful crowdfunding engaged Hymans Robertson to apply the UK alternative finance industry, it intention. It’s not fraud – the money beat a deflationary economic cycle, to-peer platform (i) entering into an campaigns from the last four years on the Prudential Regulation Authority would be a mistake not to mention a is put to work – it’s just put to work in and the market-leading rates of certain agreement with a third party back- Crowdcube, Seedrs, SyndicateRoom and (PRA) banking stress test to their own high profile platform in Europe which a different opportunity, perhaps for peer-to-peer lenders are catching your up service provider to take over the Crowdbnk with Companies House data. lending book. They modelled how the has had to suspend its services in very good reasons. The highest profile eye, but you have a nagging suspicion management and administration of loans would perform if UK GDP drops by early October 2015. TrustBuddy, a As you would expect, the proportion example of this was on Seedr’s where that those rates are too good to be the platform in the event of platform 4% on a cumulative basis, interest rates Swedish peer-to-consumer platform, of successfully funded firms that are well known city superwoman Nicola true. You know that the peer-to-peer failure, (ii) ensuring that it holds climb from 0.5% to 4.2%, and inflation specialised in payday style loans for still active is higher for more recent Horlick raised £150,000 to launch a lending market is largely untested in sufficient collateral in a segregated jumps from 1.8% to 6.6%. (Note: UK GDP much of its lifespan, having originated fundraising years (there having been restaurant in Chiswick. After a number an economic crisis, and so what really account to cover the costs of managing dropped 7% in the 2008 financial crisis) over €232 million in loans since its less time for things to go wrong). of setbacks the plan was changed and happens in the event of a peer-to-peer and administering the platform while launch in 2009 and even managed to she opened an Oyster Bar in Clapham. As The bottom line, results wise, is that platform meltdown? the loan book is wound down; or (iii) Given the commonly held assumption list on the Swedish stock exchange, far as we know, this has been a success, even in these extreme economic arranging for a third party to act as that half of all companies fail in their OMX. Its share price stood at SEK 1.20 Each lender on the platform (i.e. the but it demonstrates the lack of control conditions the average annualised guarantor for all loans outstanding. first five years, equity crowdfunded in November 2014 and by May 2015 ‘investor’) has a legal contract (a loan investors have as small-scale of unquoted returns for Funding Circle investors Most platforms choose to make companies appear to be doing better was down to SEK 0.44. agreement) with each borrower to equity as minority shareholders. remained upward of 5.5%. Annualised arrangements with a back-up service than expected. Indeed only 12.5% which he/she lends. In theory, the bad debt rates rose from 2.2% to 3.4% In September 2015, a change of provider. Lenders can take comfort of companies funded in 2011 have lender takes no counterparty risk on at peak on a yearly basis. Over the management occurred and the if such provider is another reputable dissolved. However, it is difficult to say if QUANTIFYING PEER-TO- the peer-to-peer platform itself – it only 3 year stressed period, the Hymans attempt to turn the platform around company. many crowdfunding investors expected PEER LENDING RISKS takes counterparty risk on the borrower, Robertson analysis suggested that bad revealed many more problems. 37 more than 10% of their portfolio to BORROWER DEFAULT and trusts that the peer-to-peer In the event of a platform meltdown, a debt would be at 2.5% at year 1, peak at million (£2.8m) of the 300 million SEK return zero. platform has adequate underwriting lender may also be able to look to any Quantifying this is linked to the issues 3.4% after year 2, and begin to fall again (£22.6m) lent through the platform processes in place to reduce such risk contingency fund a platform has put in There has also been one genuine exit (not around the lack of track record: we in year 3. had not been allocated to lenders, and and spreads the risk across a number of place. The monies in a contingency fund just a crowdfunding round prior to an won’t know if the loans that the it was found that lenders were owed On the surface of it, these examples borrowers. If the peer-to-peer platform are often held on trust for all lenders AIM listing that was already scheduled, platforms are writing today are any 44 million SEK (£3.6m) more than look good - but as we said above, they is no longer operational, the lender still on the platform and so if the lenders as was the case with the MILL Residential good or not until they reach their full what was held in the client accounts. don’t model the risk in an investor’s has its legal rights against the borrower are out of pocket as a result of the REIT). E-Car Club raised £100,000 in 2013 term. Furthermore, we can't really It wasn’t long before the Swedish FSA unique portfolio. When browsing the (i.e. to receive money from the borrower platform's failure, they may be able to from 63 investors via the Crowdcube assess their underwriting until a stepped in and ordered the platform sites, you can find expected overall under the terms of the loan agreement ask the trustees of the contingency fund platform. The business has just been sold platform has been through the full to suspend its services from 7th default rates, but they’re not given with and to enforce the loan in the event of for any monies they have lost as a result to Europcar, Europe’s foremost car rental business cycle. To their credit, the October, 2015. The new management upper and lower bounds, or given in non-payment). of the platform’s failure. The operation company. Though exact figures are yet platforms are aware of this and trying team has said their “investigation different economic scenarios or broken of a contingency fund in an insolvency to be disclosed, the 63 private investors to address it: Zopa, RateSetter and showed a number of breaches against The lender’s monies (both monies down by credit score. We think that scenario is untested though and so will reportedly receive “a multiple return”, Funding Circle make their full, inception internal and external regulation” and ready to be lent to borrowers and to there is a lot more useful information reliance should not be placed on the reported to be between two and three to date, loan books available online for it was likely to have been going on be received back from borrowers as that platforms could be providing to size of the fund. times their initial investment. anybody to analyse and calculate their since the platform launched. Later interest and capital repayments) are help investors quantify default risk. own default rate. in October, the platform filed for required to be held in a segregated Of course no peer-to-peer platform is ASSET MATCH One point worth noting - the P2PFA bankruptcy and the decision to shut client monies account. If the correct covered by the FSCS and so a potential Zopa, the longest standing platform, standardised the methodology for its doors was officially decided. procedures are followed, such monies lender through a peer-to-peer platform Asset Match are worth mentioning in has a default rate of 0.6% (as of July calculating defaults back in June 2014, While this is definitely an example will be ring-fenced on the peer-to-peer should look towards a trusted brand despatches while we are discussing 2015) since their launch in 2005, which so for sites that are members of the of worst-case scenario, it is best to platform’s insolvency. and the calibre of the management liquidity in unquoted shares. Asset compares very favourably to other P2PFA, it is possible to make meaningful keep in mind that the UK platforms in deciding where to place their cash. Match provides an online marketplace lenders. This has come down from So how does the lender continue to comparisons. have pushed for regulation and want Adherence to the P2PFA (Peer-to-Peer for buyers and sellers in privately held a high of 0.88% in 2012. As the only collect the money from the borrower, shares. It’s not a free-for-all: they limit it to be enforced. Swedish platforms Finance Association’s) code of conduct peer-to-peer platform to live through OPERATOR INSOLVENCY especially if the borrower is anonymous are only regulated under the existing is also something which may provide it to companies it has performed due the 2008 financial crisis, they provide to the lender and his/its identity is only consumer and business lending rules additional comfort to a lender. One diligence on and rather than being a unique data point - loans they wrote In theory, as the platform was only known by the peer-to-peer platform? Is and it is the feeling of the industry is thing’s for certain though – in the event open year round like the stock market, in 2008 exhibited a 10x jump in default matching borrowers and lenders, the counterparty risk against the peer-to- the original TrustBuddy management of a peer-to-peer platform’s meltdown, each company will have its own auction rate. This kind of data is the best underlying contracts should still be in peer platform replaced by operational was using the new and exciting fintech a lender’s capital is likely to be tied up periods (usually quarterly). It’s a great option for assessing default rate risks place, and an administrator can step in risk? to carry out shady business practices. for longer than intended while the loan FinTech innovation that will hopefully on platforms at the moment, with to run off the book (the FCA regulations However it should be a reminder that The FCA requires a peer-to-peer book is run off” expand to provide a useful service the big caveat that it doesn’t look at oblige the platforms to have this plan alternative finance investments still platform to put in place systems and and meaningful liquidity for both the risk within an individual lenders’ B in place and ready to go). Jonathan require due diligence and should only controls to ensure that loans continue to investors in unquoted shares and small own portfolio - which could be a very Segal, Partner at Fox Williams LLP takes form a small percentage of a total be administered in the event of platform Contributed by Jonathan Segal companies who want to raise money. different story. a closer look at this process for us: We understand that about £18million investment portfolio. failure and, if necessary, a third party is has been traded to date.

34 34 35 “One thing that can be certain over the next few years is that interest rates will rise. We don’t " Investors must understand the true value of the security and how easy it is to collect in case of know by how much but the direction is assured" Geoff Miller, GLI Finance default." Angus Dent, ArchOver

There have also been a small number our sense is that this phase of the What is perhaps a less obvious, but companies when they raise money, We don’t know how many businesses equity. The two differences here are - less than half a dozen according to growth of the industry has passed – our more pertinent interest rate risk is what so the platforms themselves have successfully raise money on these the fact that the valuation is not a our research - of alternative finance view is that any new entrants into the lower interest rates will mean for banks’ an interest in seeing businesses platforms and how many fail; and product of dynamic tension between websites that have launched and sector today will be backed by very large ability to write business. Freed from the raise money at higher valuations - a we don’t know how many of those the issuer and investor and the fact that then either disappeared or simply businesses. shackles of abnormally low margins, clear conflict of interest that must be that have been successful are still in investment has been made so easy. become inactive, apparently without banks’ risk appetite will increase managed. business and how many have gone bust. Interest Rate Risk? Peer-to-peer lending will be a new asset any consumer detriment. We can and they will start lending again. And of those that are still in business, Another aspect to interest rate risk We’ve had a real life example of the class to a lot of investors, and perhaps only assume that these were a mix of The question for alternative finance we have no information on how well is the contention that when base issues around valuations. In April does expose them to risks that they chancers and idealists who realised very platforms is will they be competing they are doing - what are they valued rate rise again, peer-to-peer lending 2015, Camden Town Brewery raised have not been exposed to before. But quickly that these businesses are harder with you for deals? If the answer is yes, at now, how many people are they will suffer as investors move back about £2.3 million from over 2,000 they are by no means unquantifiable to launch, and much, much harder that could present a real challenge employing, how much they are turning into conventional bank deposits. We investors for a 4.54% equity stake on risks that investors cannot understand to scale then they first thought. The for the platform. This suggests that over or how much profit they are think this is debatable - peer-to-peer Crowdcube. This gave the company a - provided they have access to the right highest profile example here was Wonga, platforms operating in niches that making. lending platforms should still be able to £75 million valuation, but at the same information. the payday lender which launched a peer banks don’t want to compete in have a maintain their margins, and still have time a Belgian manufacturing company to consumer lending platform called more sustainable business model. For And of course the platforms themselves lower costs and therefore be able to invested £10 million for a 20% stake - Invest and Borrow. It appeared to take these platforms, forming cooperative "We are at an important are aware of these risks, and many of offer better rates than the banks. But if valuing Camden Town Brewery at £50 a margin of around 90% for itself, and relationships with banks could be a real them have developed business models rates go up and inflation stays low, there million, a 33% drop in the valuation. inflexion point for the rapidly didn’t last more than a year. positive that assists with deal origination. or innovations that try to mitigate them is a chance some consumers will decide expanding alternative finance More on this in our concluding sections. In this instance, investors were able - something that we will cover in more Because of the nature of these abortive they don’t want the additional risks that This brings us to the final risk we want to to buy shares on the basis of the industry. Losses are now being depth in the next section. launches, they’re very hard to track, but come with peer-to-peer lending. consider in this section. lower valuation - they got a larger incurred, investor appetite is KEY FINDINGS stake for the same price. But it does What Happens When Inflows Dry Up? being tested and companies serve to highlight the very serious PLATFORM FAILURES are becoming selective about No asset class can continually receive concerns about the crowdfunding net inflows of investment. The tide valuation process. It’s difficult to avoid which providers to work Risks that are common to all comes in, and the tide goes out again the suggestion that a lot of equity with. We have the firm alternative finance platforms include: – and when it does, we’ll find out who’s crowdfunding might be little more than 1% belief that through continued no FSCS protection, no track record, been swimming without their trunks on, “pump and dump” schemes. professionalism, improved lower levels of scrutiny, incentives to as Warren Buffet famously put it. THE LACK OF DATA transparency and a focus on chase volume, fraud and regulatory When inflows dry up, smaller peer-to- risk A big issue with crowdfunding is the lack peer lenders will struggle - not just to delivering real investor value of quantifiable data. Now, some of this Peer-to-peer lending has the create liquidity - but to stay in business. the alternative finance industry is understandable, and a lot is not. specific risks of borrower default, Their business is matching lenders and offers exceptionally exciting operator insolvency, interest rate borrowers, and if they have no lenders, It is understandable that there have times ahead for a lucky few." and liquidity risks they have no business. This is another not been many exits - a sale or listing reason to back platforms that either that means there is a capital gain James W Sore, Syndicate Room Crowdfunding has the specific have deep pockets (think big owners) for investors - to date. As we stated risks of valuation, dilution and exit above, exits are hard to achieve and or a very finely honed niche where they Identifying these risks is easy, but take some time to bring about. With CONCLUSIONS can continue to originate lenders (think quantifying them can be more equity crowdfunding only being a We think that there are a couple of tapping into motivated communities problematic such as people who want to support few years old, the lack of data on this points to make here. Of course there Platform Failures to Date renewable energy or student lending point is simply down to time, and we are risks in both peer-to-peer lending for example). won’t be able to judge the success of and crowdfunding, but actually a In the UK, the biggest failures to date have been Quakle, Yes Secure and Big Carrots. crowdfunded businesses getting to exit lot of the risks are not unique to the We also saw GraduRates absorbed into RateSetter in 2014. alternative finance sector. QUANTIFYING for a little while yet. It’s going to be a It seems apparent that all of these failed because they had not invested the time key metric once we can measure it and CROWDFUNDING RISKS Certainly, in crowdfunding the risks and effort into building the right credit models - they were overwhelmed by the the evidence from other forms of angel VALUATION of investing at the wrong valuation, number of bad debts they faced. As we understand it Yes Secure investors did get all investing suggests that the number of getting diluted as a small investor and of their money back, but there is no record of how successful investors in the other Company led valuations will always be exits will be quite low. not being able to exit the investment two platforms have been in recovering their money. All three platforms were tiny in problematic. This is compounded by What is less understandable is that (as well as the simple fact that most comparison to the market leaders and cumulatively probably accounted for less than the business model of the platforms, there is very little data on aspects of small companies fail) are risks that have 1% of the market. which are paid in part by the investee crowdfunding that can be measured. always existed when buying unquoted

36 37 16 14 3 4 2 1 10 3 PEER-TO-PEER LENDING PLATFORMS BY FOCUS Property SMEs Particular Asset backed Specific Student Generalists Specific USPs & RISK MITIGANTS UK region lending profession finance sector

Time for a bit of a deeper dive into the TAXONOMY #2 sector. As we’ve already mentioned, AN IN-DEPTH TAXONOMY OF ALTERNATIVE FINANCE Innovation charity NESTA and the University of Cambridge have been researching there are actually lots of differences and publishing on the alternative finance sector since at least 2011. In their 2014 between the platforms - differences “Understanding Alternative Finance” paper they provide a detailed and useful in specialisms, differences in business PEER-TO-PEER (P2B) BUSINESS LENDING DONATION-BASED CROWDFUNDING taxonomy (on the right hand page), which has a little bit more detail than the one we and operating models, differences in used in the introduction. Debt based transactions between Individuals donate small amounts to the ways they structure investments individuals and existing businesses which meet the larger funding aim of a specific and differences in the ways they try However, it is possible to break the sector down still further depending upon whether are mostly SMEs with many individual charitable project while receiving no to mitigate risks. We’ll examine those they are specialist or generalists when it comes to sourcing and assessing borrowers. lenders contributing to any one loan. financial or material return in exchange. differences in this next section.

DISTRIBUTION OF PLATFORMS (UK) In our research we identified 102 platforms in total, 88 of those are still operating in the UK: 2 PEER-TO-PEER (P2C) CONSUMER LENDING REWARD-BASED CROWDFUNDING EQUITY CROWDFUNDING: PEER-TO-PEER LENDING: individuals donate towards a specific 33 53 Individuals using an online platform project with the expectation of receiving 20 platforms - UK start-up and growing companies 14 platforms - peer-to-consumer to borrow from a number of individual tangible (but non-financial) reward or lenders each lending a small amount; 1 platform - the gambling industry 29 platforms - peer-to-business product at a later date in exchange for most are unsecured personal loans. 4 platforms - property 88 12 platforms - both their contribution. PLATFORMS 2 platforms - ethical companies (UK) 2 platforms - high tech industry

3 platforms - renewable energy INVOICE FINANCING

INVOICE TRADING EQUITY-BASED CROWDFUNDING

Firms sell their invoices at a discount to a Sale of a stake in a business to a number pool of individual or institutional investors of investors in return for investment, select their own borrowers and the some both. All of them offer a range of in order to receive funds immediately PEER-TO-PEER OPERATING predominantly used by early-stage firms. amounts they want to lend. loan terms. Some allow borrowers to MODELS rather than waiting for invoices to be paid. repay early, others do not. As well as these specialisms, platforms Some platforms explicitly make can also be distinguished by their the credit risk part of the lender’s In addition, the fees they charge to operating model. In the peer-to-peer decision making process (giving them borrowers and lenders and their world, there are different ways of an opportunity to outperform by minimum and maximum lending matching lenders and borrowers, seeking out better deals) and some amounts also vary. which can broadly be split into try to remove the credit risk as far DEBT-BASED SECURITIES PENSION-LED FUNDING In short - collectively the platforms two: Marketplace and Auction. In a as possible (by having a contingency Lenders receive a non-collateralised Mainly allows SME owners/directors to offer lenders and borrowers access marketplace model the lenders offer fund) so lenders are more passive, debt obligation typically paid back over use their accumulated pension funds in to the entire range of lending activity. funds at defined interest rates and in an and the interest rate and term are the an extended period of time. Similar in order to invest in their own businesses. For retail investors, this is perhaps the auction (technically, a reverse auction), only variables in their decision making structure to purchasing a bond, but with Intellectual properties are often used as biggest innovation: they can now access lenders bid on loans with the lowest process. Some platforms give their different rights and obligations. collateral. all of these markets directly whereas rates winning. borrowers a credit score (and obviously previously they would only be able to lenders then have to assess how robust There are lots of models sitting beneath place their money on deposit with a the platforms’ credit models are). Some this broad distinction though. Some bank. platforms invest their own money platforms offer automated functionality alongside their investors, giving them Perhaps it is worth examining some of - lenders can set their lending criteria COMMUNITY SHARES some skin in the game as well. Some these concepts in more detail: and the platform will automatically allow investment in loans alongside The term community shares refers to bid on loan opportunities that meet Contingency fund: This was a institutional investors at a fixed withdrawable share capital; a form of their criteria. Some platforms just offer concept pioneered by RateSetter, who percentage. share capital unique to co-operative and “products” - you can lend for a fixed call it their Provision Fund, with the community benefit society legislation. This term at a set rate, putting your faith in Some platforms only make repayment intention of mitigating credit risk as far type of share capital can only be issued by the platform to choose suitable loans loans, some offer repayment and as possible, leaving people free to make co-operative societies, community benefit Source: University of Cambridge (2014) and diversify investors. Alternatively, interest only. Some only offer fixed rates their decisions based on interest rates societies and charitable community lenders can choose to research and to lenders, some only variable rates and (they set the rates - hence “RateSetter”). benefit societies.

38 38 39 “In order to allow investors who have different risk parameters & return requirements to all "In the near future, demand from sophisticated investors will see the need for a model that bridges participate in the same loan, Proplend pioneered the Peer-to-Peer Tranche Model” the gap between the less sophisticated crowdfunding approach and the more professional and Brian Bartaby, Proplend mature and Venture Capital markets." James Codling, VentureFounders

In our research we found that nine choose between. Lenders are appeal to different people, depending be allowed to do what they want with associated with having lots of small platforms have now adopted this essentially passive, simply choosing the on whether you are an institution, an their money? Being able to access the shareholders for the investee business, PRE-EMPTION AND TAG-ALONG innovation and have some kind of a product and trusting the platform to unadvised consumer, a financial adviser, kinds of investment opportunities that simplifies administration and in theory These are all concepts in corporate contingency fund. The fund is used diversify them across a range of loans a SIPP or SSAS operator, a workplace were previously only the preserve of the means that the platform can have some law designed to protect investors’ to repay capital losses to lenders in that will pay them the required rate. pension trustee or otherwise; the very wealthy is progress and a genuine influence over the board to protect the rights as companies grow and raise the event of a default and is built up Investors can choose to have their peer-to-peer sector certainly cannot be “democratisation” of investment. By rights of their investors. more capital. by charges on the borrowers - a small income paid away or reinvested. This is dismissed in one fell swoop, because lowering the minimum investment has Pre-emption ensures that percentage of their fee is placed into the a great way to passively access the asset there is as much diversity here as there amounts and transaction costs, by developed a model where ordinary retail existing investors have the right (but fund. class, but does mean that the investor is is in mainstream funds. reducing the time and effort required to investors can co-invest with experienced not the obligation) to maintain their putting their faith in the platform’s source and select opportunities and by The funds work in one of two ways. business angel investors and are level of shareholding in a company if ability to originate borrowers, assess CROWDFUNDING cutting out expensive intermediaries, They either step into a borrower’s guaranteed the same terms. This gives it goes on to issue further shares as their creditworthiness, mitigate the OPERATING MODELS it can be argued that the platforms shoes when the borrower fails to make investors some assurance that thorough part of a subsequent fundraising credit risk and diversify their portfolio. are doing retail investors a great payments and fulfill the contractual Although the peer-to-peer market is due diligence has been carried out on round. Generally, if a company is It also means that lenders potentially service - not to mention the investee payments (interest and principal) for much bigger and seen as the more the investee company, that the valuation raising more money, it is growing can’t access the best deals that more companies who are accessing the funds. the remainder of the loan term (this is investible asset class, there is still an has been set by the investor and not the which is good for the company. An active investors might uncover. how RateSetter’s fund works), or repay awful lot of diversity to talk about As usual, the truth probably lies company, and that they are being treated investor should have the opportunity principal and any interest owed as a Autobid: Investors set their lending in the crowdfunding sector. Just like somewhere in between these two fairly and hopefully won’t be diluted at a to take advantage of that growth. lump sum at the point that the borrower criteria, using variables such as credit peer-to-peer lending, the headline poles. There’s nothing new about later date. Tag-along rights ensure that, if a defaults (Zopa fund works like this). rating, maximum individual loan size, activity is simple and nothing really equity investing, it’s always been is widely regarded as potential purchaser makes an offer With neither model is the lender out of minimum number of loans, minimum new: providing investors with the risky, and dodgy equity promoters the original equity crowdfunding site to buy a majority shareholding in the pocket, but in the second model they interest rates (or maximum - in a opportunity to purchase equity in and salespeople are an occupational and offers two products alongside the company, investors are able to have more reinvestment risk. When marketplace if lenders set rates too high companies. But underneath that, hazard. But sensible allocations, direct equity investments available on participate in the sale at the same looking at the size of a contingency borrowers will reject them and their there are a whole range of issues and diversification, research and due its platform. One is a venture fund, price per share. This means that fund and comparing it to the size of money will sit idle). This is a compromise innovations to get to grips with. diligence are the best way investors can where a professional fund manager will small investors can benefit from any the outstanding loans - all other things between actively seeking out individual mitigate against catastrophic losses. On the one hand, perhaps it’s logical select and manage investors’ portfolios good deals struck by the majority being equal - a mature contingency fund opportunities and passively investing in to start with the risks. There is no Between them, the equity crowdfunding on their behalf. (Crowdcube still offers shareholders. that operates in a similar way to the first a product. doubt that equity crowdfunding is, on platforms have developed a couple this on their website, but the original example needs to be bigger. The products and autobid functions the whole, more risky than peer-to- of innovations to assist investors: fund management firm that launched As well as these three major innovations, Legally the fund is owned either by go some way to solving one of the peer lending. Equity is generally more this initiative has moved their operation there is also the same variety of specialist trustees or a separate company, for problems with investing in peer-to- risky than debt, and equity in small, offers a unified nominee onto the Seedrs platform.) The other is platforms as we find in peer-to-peer, the benefit of the lenders who will have peer lending via a SIPP: the perceived unquoted companies is the riskiest structure, so that, whilst the investors mini-bonds, which are unsecured retail with specialisms ranging from particular beneficial access to it in the event of need to carry out due diligence on each of all. And being a small shareholder are beneficial owners of the shares, the bonds that are typically offered by more regions, to high tech investments, a default. Platforms with contingency individual loan. Investing via a product (as most crowdfunding investors platform acts as the legal shareholder. established (but still small and often renewable energy, social enterprises, funds usually publish how large or autobid methodology should ensure are) brings additional risks with it - This avoids some of the complications early stage) companies. property and gambling, amongst others. the fund is and how much of their that all of the underlying loans meet the individually at least, small shareholders outstanding loans it covers, with a same criteria. This starts to feel similar exercise very little influence over the comparison to their expected default to investment via a GDCV (Genuinely board and run the risk of having their CROWDFUNDING PLATFORM OPERATING MODELS shares diluted further down the line. rate. Of course (and to their credit the Diverse Commercial Vehicle) which is There are differences in the operating models of the platforms. They undertake differing levels of due diligence on the firms selling platforms are explicit about this) the SIPP acceptable. They also feel closer What this means is that anybody equity and have different rules and time limits for fundraising campaigns: contingency fund is NOT a guarantee to something that IFAs could advise browsing crowdfunding websites and it is not regulated by the FCA or on: assessing the platform and then needs a healthy regard for the principle PRA. They are similar in purpose to the choosing the right risk return profile for of caveat emptor. It’s something capital adequacy requirements imposed their client is comparable to assessing a that concerns the FCA, because the on banks and insurance companies by provider and then their product. platforms make accessing these 54% 0% 46% rules such as Basel III and Solvency II, In summary, there is a huge amount investments very easy, and the fear is “ALL OR NOTHING” “KEEP IT ALL” “TIPPING POINT” but are not subject to anything like the that unwary investors are caught up of diversity in the peer-to-peer sector If the investee doesn’t the investee company the investee company same level of supervision or scrutiny. in the hype and make inappropriate, and every kind of lending activity hit its fundraising target, takes any funds raised only keeps the funds Defaults could exceed the value of the unsuitable (or, let’s face it, downright is available for investment. Yes, the all of the funds pledged once they exceed a fund and lenders would then suffer stupid) investment decisions. headline activity is matching borrowers to date are returned to predefined hurdle capital losses. and lenders, but once you look beyond On the other hand, why shouldn’t investors “Products”: Some platforms that there is a myriad of different ordinary investors have access to these package up the loans and simply offer a opportunities in the marketplace, all investments? Caveat emptor cuts both small range (say, three) of loan terms with different risk and return profiles. ways - if the buyer accepts responsibility and interest rates for consumers to Obviously different models are going to for their actions, why shouldn’t they In our research into UK based crowdfunding platforms, 13 operated an all or nothing model and 11 operated on a tipping point model

40 41 PEER-TO-BUSINESS “Another key point to note and major selling point: the majority of the investments offered on the equity crowdfunding platforms are either EIS or SEIS" ArchOver is a leading UK crowdlending platform with a remit to bring high value Investors seeking secured returns together with quality Borrowers looking for flexible and economical finance solutions for their businesses. ArchOver’s model is peerless in terms Another key point to note and major new classification for these instruments project and the investment seems good of its approach to securing lenders’ capital. All loans over the ArchOver platform are Secured and Insured. ArchOver’s mission is to selling point: the majority of the in PS14/4 as “non-readily realisable - the debentures run for 20 years and provide the most professional and usable online marketplace to connect Borrowers with Investors. investments offered on the equity securities”. In our research into UK based pay either fixed or variable returns bi- crowdfunding platforms are either EIS crowdfunding platforms, seven offered annually. 20 years is about the lifespan TYPE OF INVESTMENTS TYPE OF INVESTORS TYPES OF RISK MITIGANTS (Enterprise Investment Scheme) or SEIS mini-bonds and two offered debentures. of renewable energy installations before We offer fixed term, fixed rate loans The ArchOver crowd is made ArchOver allows businesses to borrow (Seed Enterprise Investment Scheme) they need any serious maintenance, and These debt instruments are worth from 3 months to 3 years with up of individual investors and up to 80% of the value of their Accounts qualifying, meaning that investors can the income is underpinned by the feed- closer examination, because even in returns between 5.5 - 8% per annum. institutional investors: Receivables (ARs). Once the loan is claim generous tax reliefs - for more in-tariff, which guarantees the price this small sub-sector of the alternative made they must maintain their ARs at on EIS, download our EIS Industry Reports, for the electricity that is generated. Investments are in multiples of Individual investors made up of finance market, once again we think a minimum of 125% of the value of the available on www.intelligent-partnership.com. The capital is repaid across the lifetime £1,000. There is no maximum sophisticated, high net worth and that there are wide variations between loan (monitored monthly by Archover). of the loan, along with the interest. providing it forms a balanced part of ultra-high net worth individuals on There have been some other interesting the different investments on offer. your investment portfolio average lend £5,000 and upwards Secured: ArchOver register a ‘First developments in UK crowdfunding At first glance the concept of providing per transaction Floating Charge’ at Companies House on recently. Security of 125% and insurance debt to an early stage company might cover every loan on the Archover Institutional investors: Our the Borrowers ARs. If a Borrower Firstly, some AIM listed firms have been feel risky. How does the company PROVIDERS IN FOCUS platform institutional crowd is made up of defaults we collect the AR carrying out further fundraising via generate the cash to service the debt We have mentioned it a lot leading institutions, family offices, schools, crowdfunding platforms. As AIM shares and repay the principal? Most (but Loans start at £100,000 with no Insured: The ARs are insured by up to this page, but it is extremely wealth managers and other similar have been ISA qualifying since 2013, not all) of these debt instruments are maximum. The loans are secured global rated credit insurance firms that important that advisers realise organisations that share our low risk these have been claimed as the first unsecured and will be behind more and insured against the Accounts carry out additional due diligence on the that any two alternative finance appetite examples of crowdfunding via an ISA conventional lenders in the queue to get Receivable of the Borrower Borrowers and their customers before platforms are not the same. This (although if you were to place the shares their money back should the investee they reach the platform. The insurance industry is very innovative and there in an ISA, you would forgo the much firm go into meltdown. From this pays out on default/late payment by are a variety of business models out more generous EIS benefits). Secondly, perspective the FCA’s decision to classify firms listed on the ARs. Investors are the there. Advisers should look deeper we’ve seen examples of crowdfunding these debt instruments alongside loss payee on the insurance policy into the platforms and examine who WHO WE LEND TO sites jointly hosting IPOs for firms equity and call them all "investment they lend to, how they mitigate risks We lend to B2B UK businesses with a minimum turnover of £1.2m that have been ArchOver insists on face to face listing on AIM, and of crowdfunded based crowdfunding" makes sense. and the due diligence they carry out trading for at least two years. ArchOver is the first Crowdlending platform to offer meetings with potential borrowers, the firms exiting via an IPO on AIM. We competitive loans leveraged against the quality of a Borrower’s customers. ArchOver Mini-bonds on their borrowers and fundraisers. loan is monitored monthly and all think that both of these developments works with well managed businesses that historically have strong Accounts Receivables lenders and borrowers money is held in are very positive as an AIM listing However, on the other side of the coin, The following section has been (ARs). These ARs are valued significantly above the amount of money that the client accounts (CASS7 compliant) provides much needed liquidity and investors are rewarded with higher provided by the alternative finance businesses want to borrow. demonstrates that it is possible for interest rates over shorter terms. providers that have agreed to cover ArchOver is part of the Hampden investors to successfully exit. They have more certainty over their the costs of designing and printing Group who manage in excess of £2bn in returns and eventual exit than equity this report. They are profiled here so assets DEBT INSTRUMENTS investors do. Mini-bonds can be (but that readers can get a feel for how It’s also important to mention debt are not always) listed and are usually each of them operates. These pages DUE DILIGENCE instruments. These fit into a bit of a grey approved by an authorised person and do not qualify for structured CPD. Risk management is crucial to Borrowers must have been trading for The next stage is a review of the area in the alternative finance world. verified by a law firm for promotional Whilst the platforms have had some ArchOver’s operational model and a minimum of two years, during which management accounts and future Although they are debt, they are not the purposes. (For more on mini-bonds, input and participation in putting defines our approach to both Borrowers time they should have built up recurring projections for loan term requested. small slices of loans of the kind that fit see our report on the mini-bond asset the report together, we stress and Investors. ArchOver has a low trade and a clear understanding of The management accounts must consist into the peer-to-peer space, and as such class available for download from www. that the work has been done by appetite for risk; if a Borrower does not the volume of turnover by client going of a P&L statement showing actual to the FCA has placed them in the same intelligent-partnership.com). Mini-bonds Intelligent Partnership and any error fit our Secured & Insured model, or fails forward. This enables us to review budget, a Cash Flow, and a Balance Sheet category as equity based crowdfunding. are risky, but they are safer than more or omissions are entirely our own. credit analysis and due diligence, we the projected debtors to predict with supporting schedules, especially if However, they are not equity stakes informal loan-notes (which we have will not approve their loan application. likely fluctuations in the security. accruals and prepayments are too high. either. They take the form of either mini- seen promoted to retail investors) and This collaboration is part of our bonds or corporate debentures and can give investors a hybrid option that sits effort to work with alternative ArchOver only engages with good We demand strong management controls Projections must include P&L, Balance offer both fixed and variable rates of between equity and peer-to-peer. finance platforms to educate companies with quality clients and review any family connections Sheet and Cash Flow: all are expected interest, repayment or interest only and financial advisers on their asset whose value is analysed throughout within the management team, directors to acknowledge receipt of loan amount Debentures secured or unsecured. Some are simply class. The intention is to get the the on-boarding process. and controlling shareholders. sought, interest payable and fees. offered to potential investors and some To the best of our knowledge, only report into the hands of the 5,000 Our loans are secured against the BVD credit scores are reviewed If the Borrower’s loan application is are sold using a reverse auction process. one platform (Abundance Generation) financial service professionals who Accounts Receivable (AR) asset which alongside the current and ageing successful, the projections will be Theoretically, they are all securities that currently use corporate debentures as are most interested in this topic, fluctuate monthly, so it is fundamental creditor balances. Poor credit scores used as part of the ongoing monthly can be bought or sold on a secondary the legal structure for their investment. increasing the levels of awareness that the prospective borrowing company and a high creditor balance with monitoring and all future reports market, but of course in practice that Abundance raises money for renewable within the adviser community. can maintain their AR at the required significant ageing could indicate the will be measured against them. is subject to liquidity - hence the FCA’s energy projects and the fit between the level for the loan’s duration. We creditors being stretched for payment critically review each Borrower’s trading and subjects the Borrower to potential history and sales cycle by analysing winding up petitions from creditors. a 12-month client debtor history.

42 43 PEER-TO-CONSUMER AND PEER-TO-BUSINESS ALTERNATIVE FINANCE FUND

BondMason is the UK’s first peer-to-peer platform exclusively for investors. Investing from as little as £1,000; investors have achieved an average net return of 8.6% per annum since April 2015. In a just a few clicks, investors can invest in a highly diversified portfolio of P2P investments, sourced by BondMason from the best loans across the best peer-to-peer platforms. From rebellious teenager to fully grown adult; regulating the maturation of the alternative finance industry. TYPE OF INVESTMENTS TYPE OF INVESTORS TYPES OF RISK MITIGANTS Invest any amount from £1,000 Retail, institutional, family offices, Investors benefit from a highly Regulation. It’s a word which inherently regulation of the sector must be viewed cash used to fuel rapid growth all to in total (and invest as little as trusts, corporates etc. diversified and balanced portfolio of strikes fear into Chief Executives across and its implementation will bring make a quick buck for the unscrupulous just £10 per loan investment). 100+ investments sourced from the best the financial services sector. Greater several benefits. founders. People entering the sector Minimum investment amount of P2P loan platforms levels of compliance, increasing demand must do so because they want to build Investors invest in receivables £1,000. Firstly it will allow the sector to more for transparency and better risk serious, well-run businesses with robust which are linked to peer-to-peer debt We diligence peer-to-peer platforms effectively attract institutional capital. The BondMason team comes management are all things that don’t risk management systems in place. and loans. The BondMason P2P before approving them to our panel, Sophisticated investors are already from an institutional investor come cheap. They require investment, Investment Account enables investors approving less than 1 in 4 beginning to wake up to the returns Finally, regulation will drive background, and is pleased to work new systems and processes and can to invest in a diversified portfolio of that alternative finance can generate some sensible and much needed with intermediaries such as IFAs and The majority of loan investments are expedite the need for growth strategies 100+ loan positions across carefully in a low growth and low interest rate consolidation in the sector. It’s a dog wealth advisers - to provide their asset-backed loans, which can to be re-evaluated. selected and vetted peer-to-peer environment and a clearer regulatory eat dog world out there and only the clients with an attractive access demonstrate very low realised loss rates platforms in just a few clicks. This The alternative finance industry is no framework would only accelerate best businesses must survive. This point to the peer-to-peer investment in the event of default enables investors to invest their different, but rather than sending those this trend. As an industry we must is a good thing and it is the natural industry. money quickly and easily, and access A number of our approved peer-to- that operate in this exciting and rapidly ensure that we are able to meet the evolution of what remains a nascent it just as easily. Giving them exposure peer platforms have their own growing space running for the hills, investment criteria of institutional market. If we want borrowers to sit up, to P2P returns, through a well- contingency funds and loss protection, more stringent and better enforced players and provide comfort and take notice of the sector and have the balanced and diversified portfolio for the benefit of our investors regulation should be welcomed. Not transparency around how their capital confidence to trust alternative finance because there must be a sudden knee- is being managed and deployed. A firm providers, then we must offer them Target return to investors is 7.0% per The BondMason P2P Investment jerk reaction to the recent failures at definition around what constitutes a a compelling proposition delivered annum net, with the BondMason P2P Account has not incurred any TrustBuddy, but because there must non-performing loan would for example through modern, customer-centric Investment Account achieving 8.6%. losses since inception. be a collective realisation that it is go a long way to ensuring investors channels. There is a huge variety in the unavoidable. can accurately assess the risk profile quality of technology that supports of potential investments and enabling platforms across the industry and we The reason? Because the alternative them to build a diversified portfolio cannot afford the reputational damage finance sector is no longer alternative. SELECTING THE RIGHT PLATFORMS of assets. Attracting these types of that would be caused by any failure that Its rapid growth and demonstrable investors is crucial to the scalability of left borrowers high and dry; be that a successes in delivering much needed Our clients are able to build a balanced portfolio of 100+ loan positions in just a few platforms and is the only way through mis-selling scandal, a data leak or the growth capital to SMEs means that clicks, accessing attractive risk-adjusted returns with ease. Safe in the knowledge that which the industry will be able to collapse of a funding line. it is now a viable and crucial part of P2P BondMason is on their side and fully aligned to their interests. service the huge lending gap created the credit ecosystem. In some ways, The sector has made remarkable PLATFORM as traditional banks retrench from the BondMason carefully selects and diligences the best peer-to-peer platform partners, we have become a victim of our own progress in a short space of time. We market. that originate loan positions for our clients to invest in. We aim to achieve an annual success, and whilst the banks were have proved our worth, filling a vital return of 7% per annum net after fees and any losses to our investors. too big to fail, through innovation, The second benefit of more effective credit gap in the wake of the financial entrepreneurial drive and a willingness regulation is that it raises the barriers crisis and earning government support We have approved We only approve peer-to-peer platforms partners if they can demonstrate a good to find a better way of doing things, we to entry for new platforms. Critics through the passing of the Small less than 1 in 4 of the track record and experience of sourcing and pricing credit, and a sound set of too have become indispensable to the will argue that this flies in the face of Business Enterprise and Employment UK’s P2P platforms processes to manage borrowers. We conduct our own analysis and due diligence on UK economy. competition, that it’s “not in the spirit” Act. The opportunity to continue P2P to join our panel each platform, giving our clients comfort that they are investing appropriately. of entrepreneurialism or that a bigger reshaping the credit ecosystem is there PLATFORM What’s more there are greater things more fragmented marketplace is a good for all to see but to seize it we must P2P to come. One only has to look at the From our panel of approved peer-to-peer platforms, we source loans which have a thing. Nonsense. Raising the barriers embark on a regulatory journey that PLATFORM projected trajectory of origination risk-return profile to suit our clients’ needs. We have a bias toward asset-backed loans to entry achieves one fundamental shifts the industry from that resembling volumes to realise that demand from and loans which can demonstrate characteristics of minimising any risk of default, as objective that must not be forgotten; it a rebellious teenager to a fully grown borrowers and awareness levels of well as minimise any expected losses in the event of default. means that management teams must adult. the benefits of alternative finance take a longer term view. No longer can continue to grow. It is through this lens platforms be sprung up with investors of opportunity that more stringent FACTS:

We have experience of We have achieved 8.6% We have not invested in any successfully investing over per annum since starting loans that have realised £2bn over the last 15 years in April 2015 losses, or defaulted to date

44 44 45 PEER-TO-CONSUMER AND PEER-TO-BUSINESS PEER-TO-PEER LENDING

Landbay is an online peer-to-peer lending platform that offers retail and institutional investors the opportunity to lend money Proplend is an online peer-to-peer lending platform that allows investors to lend direct to borrowers with loans secured against UK directly to property investors through UK residential buy-to-let mortgages. All loans are secured by first-ranking mortgages over income producing Commercial Property. All loans are supported by a 1st legal charge and can offer 200% capital protection. Proplend’s tenanted residential properties across England and Wales. The Landbay platform simplifies the traditional lending process, offering simple, secure and transparent online platform allows borrowers to gain access to funding otherwise not currently available, and a direct transaction between lenders and borrowers. investors access to low risk, fixed income returns.

TYPE OF INVESTMENTS TYPES OF RISK MITIGANTS WHO WE LEND TO TYPE OF INVESTMENTS TYPES OF RISK MITIGANTS Proplend Loan Tranche Model: Invest any amount from £100. Diversification of investments – Our mortgages are available to Commercial Property: Office, Investors are able to build a • Not every investor has the same spreading each investment across experienced buy-to-let landlords via our Industrial, Retail, Leisure & diversified loan portfolio of multiple loan risk profile or investment return 3 YEAR FIXED. 4.4% annualised multiple mortgages helps protect our FCA-regulated and accredited mortgage Residential Blocks parts by geographic location, property requirement Earn a fixed rate of interest for three lenders' money from the effects of one broker partners. type, interest rate and loan term Investors get to choose loans on a • For this reason, Proplend pioneered years, before switching automatically borrower missing a payment or We fund mortgages of £70,000 - deal by deal basis via: Rigorous credit and due diligence the ‘Proplend Loan Tranche Model’, to our Base Rate Tracker. defaulting, or if demand falls away in a £500,000, provided that this represents process on the borrower, the property which allows multiple investors to particular area • In Funding: participate in participate at three separate LTV levels, BASE RATE TRACKER. 3.5% per less than 80% of a property’s value. This the live funding of a loan & the tenants by both Proplend and annum Secured investments – against is done to maintain a sufficient buffer in third party property professionals (RICS each with their own risk profile and • Proplend Loan Exchange (PLE): income-generating assets; tenanted case property prices should fall. Valuers & Lawyers) return levels Earn 3% per annum on top of the invest in loans that have been homes current Bank of England Base Rate We insist on rental income of at least drawn down by the borrower Investment security – 1st legal • Each tranche offers a fixed interest (BBR). Whenever the BBR moves, our Rigorous credit, compliance and Due 125% of the mortgage interest cost, and offer investors access to charge over an income producing rate of return tracker moves too. Diligence processes – to ensure that we and the borrower must have personal immediate monthly income commercial property, which can be • The higher LTV, the higher the risk and only lend to suitable applicants and income of at least £30,000 per annum sold, and the proceeds used to repay Minimum of £5,000 the higher interest rate return against properties that obtain at least (over and above any rental income). investors in the event of a default 125% rental coverage of the loan Investors have full transparency • Tranche A is considered one of the Deciding which homes we lend against Interest reserve – loan specific 6 TYPE OF INVESTORS of the borrower, the property & the safest P2P Loan investments with a Reserve Fund – we hold a is a fundamental part of the process – month interest reserve should a Retail Investors tenants minimum 200% capital protection discretionary fund derived solely from we only lend into areas with proven and borrower miss a monthly payment Institutional Investors our margin, which can be called upon to robust rental demand. Direct loan contracts between make up any shortfall should a borrower and investor average net borrower default or fall into arrears returns

TYPE OF INVESTORS COMMERCIAL 66-75% LTV TRANCHE C 9.6% p.a.* INCOME Retail Investors 51-65% LTV TRANCHE B 7.6% p.a.* R Institutional Investors PRODUCING I PROPERTY S Family Offices SEVEN STEPS OF MORTGAGE APPROVAL 0-50% LTV TRANCHE A 6.4% p.a.* K SIPP and SSAS We subject every application to rigorous analysis before we agree to lend. Our credit and compliance process is as follows:

DUE DILIGENCE PROCESS 1 2 3 4 5 6 7 Proplend’s borrower relations and underwriting team has a Professional reports are then instructed, which include a combined 60 plus years in the property finance industry. This valuation of the property to ensure that it offers adequate highly experienced and trusted team is responsible for the due security for the loan. A registered RICS Valuer completes this, diligence process and has produced a zero default rate to date. and a Certificate on Title is prepared by the borrower’s solicitor and confirmed by Proplend’s solicitor. Once a borrower has submitted an online registration form, Proplend completes a primary review to determine the viability Proplend prepares the security package that includes, as a of the loan and to assess whether or not it would be attractive minimum, a first legal charge on the property but can also to their investors. If deemed suitable an initial set of terms are include a personal guarantee, a corporate guarantee, and a agreed, and upon acceptance, the team begins a further due debenture. All security is held in trust by Proplend Security Applications are An exhaustive The Decision in We instruct a RICS Once these steps are Securities are Finally the loan diligence review. Limited on behalf of the group of lenders. made online with credit assessment Principle is only given valuation, which met, the loan and then passed to the is transferred to During the full due diligence review, Proplend visits the The loan request will contain specific covenants to which the our FCA-regulated is undertaken; for once the results of must be endorsed securities associated Security Trustee, Paratus AMC, a property and meets with the borrower. borrower must adhere, which include a maximum of 75% loan brokers affordability and these checks have by our Credit with the application who holds them in leading mortgage to value (LTV) and a minimum interest cover of 1.25x. These credit, with checks been ratified by our Committee and a are finalised with a trust, on behalf of administrator, who A credit analysis is initiated on the borrower, the property covenants will be checked on an ongoing basis. for anti-money Credit Committee leading property major law firm investors manage it until it is and the tenants. This includes a review of the properties cash laundering and fraud consultancy repaid flow and an examination of the leases. Credit checks for any Once the loan is approved and posted on the platform company, or individual, offering security on the loan and anti- investors have full transparency of the due diligence reports, money laundering checks are also performed. which they can access via their Lender Dashboard.

46 46 *After fees, before bad debts and taxes as of November 4th, 2015 47 EQUITY CROWDFUNDING EQUITY INVESTMENT

Equity crowdfunding has democratised investment in startups, helping entrepreneurs to make their business visions a reality and VentureFounders is a UK-based equity With a solid foundation in financial range of structured opportunities in allowing individuals to invest and become real-life ‘Dragons’. investment platform designed to services expertise, the VentureFounders early-stage, scalable and high growth make Angel and Venture Capital style team is comprised of FCA approved, businesses, many of which are EIS While many platforms have sprung up, at SyndicateRoom we have developed a unique model with benefits you can’t find anywhere investing more accessible, affordable highly skilled investment professionals (Enterprise Investment Scheme) else. Here's why: we only list companies that are already backed by professional ‘business angels’, who are investing their own and transparent. with extensive private equity, qualifying. money and thus have taken an active role in evaluating the strength of the deal. We then offer our members the ‘same share class investment management and business and same price per share’ if they decide to invest alongside these professionals. Venture Founders believes that this By using a nominee structure, the growth experience. market should be open to all who experts at VentureFounders ensure We believe this curated and transparent approach allows our members access to a more sophisticated set of investment opportunities. can afford and understand the risks The majority of the investment investors receive the full economic associated with early stage investment. opportunities are offered in interests of their investment with the Through VentureFounders, investors collaboration with leading Venture benefit of being part of a much larger TYPE OF INVESTMENTS TYPE OF INVESTORS TYPES OF RISK MITIGANTS can invest from a minimum of £1,000 Capital firms or Angel networks with pool of capital, with a greater say in the Investment through SyndicateRoom Our members are self-certified as All opportunities are led by a ‘lead in some of the UK’s fastest growing and established track records and sector business. entails buying equity in high being either investor’ who contributes at least most exciting companies. expertise. The result is a curated growth companies covering a wide 25% of the round. This lead investor sophisticated investors range of industries. We are the negotiates terms and conducts his/her European leader for life science or high net worth individuals due diligence. Uniquely, SyndicateRoom TYPE OF INVESTMENTS TYPE OF INVESTORS companies raising funds, which members invest at the same share VentureFounders sources liquidity from private investors VentureFounders caters to sophisticated investors who account for 35.2% of our deals. class and at the same price per share for Venture Capital and Angel backed companies, focusing understand the risks of investing in high-growth, early- Other big industries for us are as that lead investor. This balances on fundraises of £1-5 million. These fundraises range from stage businesses and who have the available capital to do hardware, engineering, software and the risk across lead investors and early-stage to Series A. so. All investors must self-certify before investing in the internet ventures. Whereas most online investors. By making the risks opportunities presented by VentureFounders. crowdfunding platforms have rarely involved clear and transparent, we moved beyond business to consumer are taking a big step towards enabling opportunities, SyndicateRoom has investors to make informed decisions. helped fund businesses in a wide INVESTMENT CRITERIA variety of industries. Overall, we’ve VentureFounders supports early-stage growing UK businesses. In order to ensure the best possible opportunity to maximise the now helped raise over £38m for returns to investors, VentureFounders undertakes extensive due diligence. VentureFounders assesses each opportunity against the almost 60 companies. Furthermore, following criteria before presenting it as an investment opportunity on its site: SyndicateRoom achieves a market- leading 80% closure rate. SIGNIFICANT SUPPORT FROM EXISTING PASSIONATE AND EXPERIENCED MANAGEMENT SHAREHOLDERS OR NEW ANCHOR INVESTORS TEAM DUE DILIGENCE PROCESS Businesses that are usually past proof of concept and have Management teams with diverse and complementary skill received significant backing from institutional investors as sets, strong business acumen and ability to translate their well as support from existing shareholders. business strategy into successful day-to-day operations. COMPLIANCE AND LEGAL REVIEW GOING FURTHER They are passionate about their company and fully invested SyndicateRoom’s team of experienced and tenacious SyndicateRoom’s investment associates go the extra mile to in making it successful. Investment Associates are responsible for the pre-launch ensure that each opportunity complies with both the terms INNOVATIVE AND DISRUPTIVE BUSINESS IDEA WITH A SUSTAINABLE COMPETITIVE ADVANTAGE review process that ensures only high quality opportunities and the spirit of the lead-investor model. Businesses that are, in their own way, innovative and disruptive. are offered to our investors. Each opportunity is subject to PRODUCT/SERVICE THAT HAS GONE PAST ‘PROOF The investment associates speak directly with each lead We often find that innovation involves some form of technology. OF CONCEPT’ AND HAS MARKET VALIDATION a detailed compliance review, focusing on the business plan investor, in order to understand the due diligence that However this is not exclusively the case and we raise funds for The company’s product or service to have already had some and any related marketing materials. SyndicateRoom then they have conducted, the negotiation which arrived at very innovative businesses outside the technology space, all of external market validation and is past ‘proof of concept’. applies a legal review of core documents, carried out by the company’s valuation and the expertise and industry which have demonstrated a high degree of differentiation and a These businesses are typically, but not exclusively, revenue an external legal team. This review is particularly focused experience they bring to the company raising funds. defendable competitive advantage. generating and have secured a strong client pipeline or order on the company’s articles of association and shareholders book. agreement, ensuring legal protections, such as pre-emption A final review focuses on the planned use of funds, historical rights, tag along, drag along and voting rights are ensured. In and forecasted financial data and a holistic analysis of the CLEAR VALUE CREATION STRATEGY WITH particular, this review ensures that SyndicateRoom investors business plan. If the opportunity is considered appropriate to MONETISATION OPTIONS FOR INVESTORS LARGE MARKET OPPORTUNITY AND ABILITY receive the same share class and same price per share as the progress, it is then presented to SyndicateRoom’s investment Fundraises that see the process as the start of a long-term TO SCALE lead investor. committee for final approval. partnership and a journey towards the business ultimately Opportunities that have the ability to deliver significant These compliance and legal reviews are designed to serve the This detailed review process has cemented Syndicate Room’s entering the next phase of its lifecycle and achieving an exit financial returns for our investors. Therefore we ensure interests of SyndicateRoom’s investors. They go well beyond reputation for quality. Investors and the wider industry have for our investors. Although an exit is likely to be a number that our businesses have the potential to achieve significant the baseline requirements set out by the Financial Conduct taken notice, naming SyndicateRoom as Best Investment of years after the initial investment, it is very important that scale within their market and that their growth won’t Authority (FCA), and are a core element of SyndicateRoom’s Platform at the 2015 Growth Investor Awards and both entrepreneurs have a firm view on potential exit routes at the be constrained by relative market size or competitive investor-led approach. Alternative Finance Platform of the Year and Crowdfunding time of the investment. environment. Platform of the Year at the 2015 AltFi Awards.

48 48 49 REASONS TO BETTER RISK SUPPORTING ACCESSING NEAR CONSIDER ADJUSTED CAUSES TAX RELIEF CASH GUIDANCE FOR ADVISERS ALT FI RETURNS

where yield can be found in today’s #2 NEAR CASH OVERCOMING SOME OF REASONS WHY ADVISERS HESITATE AND WHY THEY SHOUD CONSIDER ALT FI low interest rate environment. Money in a bank account is being THE HESITATIONS eroded by inflation. Money held on an UNDERSTANDING THE OPPORTUNITIES In the well diversified portfolio we TO HAVE A VIABLE, RELATIVELY LIQUID, TO PUT MONEY TO WORK IN INVESTMENTS THEIR investment platform (such as Transact suggested above, we think a yield of Hopefully as the sector develops RELATIVELY LOW RISK “NEAR CASH” ASSET + + CLIENTS HAVE A STRONG DESIRE TO SUPPORT or Novia for example) might actually 6% is possible. The yield on the big and awareness among the general be subject to an annual management three peer-to-peer lending platforms public grows, advisers will also come charge which exceeds the yield. So is around 5%, as measured by LARI to better understand the sector we see a need for relatively liquid, - the Liberum AltFi Data Returns TO ACCESS EIS AND SEIS TAX TO ACHIEVE BETTER RISK ADJUSTED and the opportunities available for near-cash solutions that have inflation Index. Investors in high street saving RELIEFS VIA CROWDFUNDING + + + RETURNS FOR THEIR CLIENTS IN P2P them and their clients. Initiatives LENDING beating yields with low risk and products might get 3% and the yield like this report will be part of that, volatility. We note that RateSetter, on a basket of FTSE All-share stocks and over time advisers will educate STRENGTHS for example, raises an FE rating of 1 might be around 3.5%-4% (of course LOW LEVELS OF UNDERSTANDING ABOUT themselves about this new asset class. CONCERNS ABOUT THE LACK OF (where cash is 0). It’s an indication equities mean that there is the prospect THE TYPES OF INVESTMENT OPPORTUNITIES TRACK RECORD IN THE SECTOR AVAILABLE of how advisers could start to utilise As with many other alternative of capital gains or losses in the mix as this asset class for their clients. investments though, understanding well). An investment in UK Gilts currently LACK OF UNDERSTANDING OF WHERE ISA AND SIPP ACCEPTANCE AND the asset class and buying into yields from 0.5% - 3% depending upon ALTERNATIVE FINANCE MIGHT FIT INTO #3 SUPPORTING CAUSES UNEQUAL TAX TREATMENT, OR the investment case, and actually the term. As always, the key judgment TREATMENT OF RETURNS AS CONVENTIONAL FINANCIAL PLANNING Both lending and crowdfunding offer investing clients’ money are is if the additional 2%-4% yield is worth INCOME (NOT GAINS) MODELS investors the opportunity to support two very different things. the risk, and that will always depend CONCERNS THAT INVESTORS ARE NOT LACK OF FSCS COVER businesses in ways that mainstream upon the investor’s circumstances. ADEQUATELY REWARDED FOR THE RISK THEY LACK OF TRACK RECORD ARE EXPOSED TO investing does not - even if it is just If pushed, our view would be that CHALLENGES COMPARING INVESTMENTS, supporting SMEs and helping to bridge One of advisers’ primary concerns will it is worth the risk, especially if you BOTH WITHIN THE ALTERNATIVE FINANCE REGULATORY RISK - ALSO KNOWN AS SECTOR AND WITH OTHER, MAINSTREAM “WHY STICK YOUR NECK OUT” that funding gap. Many investors will be the relatively short track record of are investing carefully in a well- INVESTMENTS THE LEVEL OF DUE LIQUIDITY take some satisfaction from that, and the alternative finance sector and the diversified portfolio as we suggest. DILIGENCE REQUIRED CONCERNS for those that are more committed, fact that it has not proven itself through Obviously equity crowdfunding has no the various specialisms, such as the entire business cycle. Until it’s clear yield and no price return index to allow funding renewable energy projects how the asset class performs through these kinds of comparisons - a reflection sophisticated investors nor high net term loans can offer some protection or student education, allow investors a recession, which platforms survive WHY SHOULD ADVISERS of how risky buying unquoted shares worth had to restrict their investment against the risk of interest rate rises, to go a stage further. We wouldn’t consolidation as the industry matures CONSIDER ALTERNATIVE is. When it comes to crowdfunding, the in crowdfunding to 10% of their net and it makes sense to diversify underestimate the value investors and which platforms have the talent and FINANCE? hope is that out of a well-diversified investible assets unless they were taking across the platforms as well. Another place on being able to feel more of a leadership to scale successfully without Firstly, we think that it’s important that portfolio, one or two investments will advice. This is an acknowledgment sensible measure would be to stick connection with the businesses that compromising quality, most advisers advisers at least have an understanding return 10x capital or greater and more that advisers have an important role to to the biggest alternative finance they support with their money. are likely to hang back with “let's wait of alternative finance and can talk than offset the losses that have been play in this sector - although it is hard platforms that generate the most and see” as their guiding mantra. knowledgeably about it to their clients, #4 ACCESSING TAX RELIEF made elsewhere. But investors need to imagine any adviser recommending volume (although this might mean whether they choose to recommend However, data is available in great to be aware that there could be a long that a client invests greater than 10% foregoing some more interesting The last point is perhaps a bit tenuous. investing in or not. Independent detail and the back history is growing wait for returns, with no prospect of of their net investible assets in an and attractive opportunities on the Yes, the lower levels of investment advisers do have an obligation to all the time. It is a feature that is an exit in the meantime – this is just equity crowdfunding opportunity!) smaller platforms). We estimate that a mean a whole new class of investors look at the whole-of-market for their almost unique to alternative finance, part of the nature of unquoted equity portfolio built like this could generate can access EIS and SEIS tax reliefs for clients and so need at least a basic So it seems as though there is some but for the biggest platforms it is and is not unique to crowdfunding. around 6%-8% yield per annum. the first time. But these reliefs shouldn’t expectation that some advisers possible to download and examine understanding of the sector. Hopefully drive the investment decisions - the tax However, we would consider at some point will be considering That’s pretty attractive, especially in their entire loan books. And AltFi Data this report goes some way towards tail should not wag the investment dog debentures to be much less risky where investment on these platforms. today’s low interest rate environment. is publishing indices of the overall addressing that for advisers. - certainly in the case of less wealthy the cash to pay the interest is coming It’s not safe enough or liquid enough market performance. This issue is It’s also worth acknowledging that some investors whose tax planning should from renewable energy feed-in-tariffs. for rainy day money, and with no being addressed by unprecedented of the alternative finance platforms REASONS WHY be centred on ISAs and pensions. If The interest rate can be compared prospect of capital gains it won’t form transparency and the passage of time. have made some (albeit tentative) #1 BETTER RISK ADJUSTED RETURNS you’re wealthy enough to have to think to other options, and an assessment the backbone of an accumulation steps towards attracting investment about what else to invest in because ARE INVESTORS ADEQUATELY of the risk vs reward can be made. It is potentially possible to achieve strategy, but it does sit nicely in from advisers, by setting up advisers your ISAs and pensions are maxed REWARDED? better risk-rated returns by investing between the two. The downside is ISAS, SIPPS AND TAX TREATMENT portals online that allow advisers out, then you’re wealthy enough in peer-to-peer lending. Yields range the time and effort it would take Are investors adequately rewarded for to register and manage cash and to invest in traditional EIS and SEIS As we said in our review of significant from around 3% to 10% per annum. to put together - and maintain - a the risk they are exposed to? There is investments online for their clients. opportunities. But the tax benefits are developments to date, peer-to-peer By carefully selecting opportunities a portfolio like this, which makes a good a danger that as more investors come a great incentive for the right investors, lending will be accepted in ISAs from well-diversified lending portfolio that case for one of the new funds in this into peer-to-peer lending, it pushes Another point is that in its policy or can be seen as a great bonus for April 2016, the government is consulting includes peer-to-business and peer- space that we mentioned earlier. the yields down - although this is a statement on alternative finance those who would be investing anyway. on including other forms of alternative to-consumer, secured and unsecured risk that exists nearly everywhere (PS14/04) the FCA explicitly stated finance in ISAs, much of the alternative that retail investors who are neither loans can be built. Choosing shorter

50 51 “The bottom line is that any investment into equity crowdfunding will be risky, as the two big FINANCIAL MANAGEMENT BUSINESS CREDIT ASSESMENT OPERATING FEES STRENGTH TEAM MODEL PROCESS MODEL things they are the valuation and their rights as a shareholder."

finance universe is SIPP acceptable have an auto bid function, or automatic Their volumes – with generalists we to say at this level it goes beyond ALL STREET REVIEW PROCESS (subject to the operator admitting it) reinvestment according to pre-set would suggest that the more volume looking at the numbers and requires All Street is the only provider of reviews we know of in the equity crowdfunding space and other inequalities about the tax criteria, or if they offer anonymised the better. Bigger inflows mean they can an assessment of the business plan, (although other firms such as MICAP and Allenbridge provide reviews of single company EIS treatment of peer-to-peer lending products, then the process can be write more business and diversify more management team and Ts & Cs of the offers), and they also cover debt instruments and debentures. They work on a subscription have already been ironed out – so thought of as something closer to a effectively. Specialists who pick a niche actual investment opportunity as well. model and provide their reports online to their members. These investigate 8 key areas: in summary, these issues are being traditional fund – there is no need to may get around this issue if they are The bottom line is that any investment successfully addressed. assess each individual loan the client good at sourcing borrowers and lenders An executive summary of Examining the into equity crowdfunding will be risky, invests in. within that niche the opportunity, potential quality, industry band the two big things that investors DUE DILIGENCE PEOPLE Their credit assessment process – returns, and risks including experience and Thus the initial due diligence INVESTMENT BEHIND THE must focus on are the valuation As we’ve noted successfully putting an assessment of the terms business background work needs to be on the platform are they good at making loans, this is OVERVIEW BUSINESS and their rights as a shareholder. together and monitoring the kind and conditions of the platform of the key themselves: the core of the business after all! Even if the business model is of diversified lending portfolio that hosting the deal and investors employees, advisors Their operating model – are retail fantastic, if the valuation is too high we’ve suggested will take a lot of work, Their financial strength – do they rights as shareholders and board members lenders treated fairly? Institutional or there is potential for dilution including an assessment of the platforms have deep pockets (or owners with deep the risks are greatly magnified. investment brings many benefits in Looking at the size of Identifies the key themselves and the underlying pockets) so that they can keep writing terms of scale and can be very much a players in the industry investments. the target market, the REGULATORY RISK - Also Known business even if inflows slow down MARKET and analyses the positive for retail investors, but can also market growth rates, COMPETITION as “Why Stick Your Neck Out” TRENDS PEER-TO-PEER LENDING PLATFORM Their management team - look for crowd them out disruptive trends and company’s strengths and DUE DILIGENCE regulation weaknesses compared If the mainstream markets crash, financial services experience on the Their fees, charges and incentives – with its competitors well at least everybody was wrong The due diligence might not be as board at an operating level, rather than are the platform’s interests aligned with together. If the adviser does onerous as it seems at first glance at a non-exec level the retail lenders? At this stage in the Analysis of the key financial data relating Analysis of the company’s something a little bit different to when it comes to peer-to-peer lending Their business model – are they development of the industry, the big to the company’s funding needs: what growth the conventional, and it goes wrong, though. Once the initial due diligence carrot of a successful IPO may be BUSINESS PLAN FUNDING NEEDS specialist or generalists current operations, the capital is supposed to there is the possibility that clients work has been done, if the platforms encouraging some platforms to chase & REVENUE & COMPANY business plan and fuel and how much money will complain and the ombudsman volume at the expense of quality. MODEL FINANCIALS projected revenue the company needs to meet will want an explanation. Regulation its goals generation in the advice sector is so tight, it can IN:REVIEW PLATFORM REVIEW PROCESS reduce the adviser’s inclination to Cross-reference and recommend certain solutions even There are services out there that offer platform reviews. Comprehensive An analysis of the loans and independent verification of if they match the client’s risk profile. The in:review review process we mentioned earlier is based on 180 PEER REVIEW analysis of what is good loan parts, their returns (and the information provided FINAL different criteria against which are used to assess peer-to-peer lending & EXTERNAL But as we noted above, the regulator by the company in their and bad about the ASSESMENT any categories associated EXPERT INSIDE has indicated in the policy statement and crowdfunding platforms. These can be categorised into seven main LOAN proposed opportunity with them) and fees crowdfunding pitch aspects. A broad outline of each aspect with respect to peer-to-peer SPECIFICS that advisers have a role to play in this platforms is as follows: asset class. Advisers will also have to consider the risks of non-involvement in these types of investment. An analysis of the conditions A review of the Platform’s attached to the loans including business continuity and disaster recovery plan, its triggers, ONGOING MONITORING to getting advisers on board – and this is early repayment, redemption, KEY FINDINGS LIQUIDITY costings and timings cancellation and transfer CONTINUITY The ongoing monitoring splits into two a step that should be easily achievable. With yields ranging from around parts. Firstly, monitoring the overall DUE DILIGENCE ON CROWDFUNDING 3% to 10% per annum, carefully portfolio to make sure that it matches Examination of the security OPPORTUNITIES This aspect covers the platform selecting a well-diversified portfolio attached to the loans, how and the specified criteria (and separately, operator’s regulatory compliance, could generate around 6% per under what circumstances it can be as part of the advice process, making Crowdfunding does not give investors including its high level controls, CASS annum enforced, the platform operator’s sure that those criteria are still suitable the option of passively investing in a compliance, AML, capital adequacy, assessment procedures on potential for the client). Secondly, monitoring product or using at autobid function Beyond the financial returns, COMPLIANCE client reporting, promotional material SECURITY borrowers, default, late payment the alternative investment platform to to invest according to pre-set criteria. supporting causes and accessing tax and its complaints procedures and contingency fund analysis see if redemptions rise, bad debts rise Each individual opportunity must be relief are other reasons advisers or if calls on the contingency fund rise. assessed on its own merits – it’s very should be considering alternative Whether investing via a member-directed much active investment management! A review of the platform operator and With the largest platforms committed finance pension scheme may lead to tax charges We think this is part of the appeal, but any ongoing counterparties, including to transparency and making their entire for the SIPP/SSAS operator through of course what it means is that each If platforms offer an autobid or their provenance, experience and loan books available, this is actually unauthorised payments, taxable property individual company raising money must automatic investment function then TAXATION regulatory record relatively easy to do. We think that if the or otherwise – only really relevant in PARTIES advisers may only need to do due peer-to-peer lenders can get together be assessed using criteria that would be the context of a SIPP or SASS diligence on the platform and with advisers, agree on the metrics they applied to any investment in unquoted monitor the platform on-going need to see and then publish them in a equity – we won’t go into fundamental These seven criteria would be a good starting point for any standard format, they’ll be a lot closer investment analysis here , but suffice independent due diligence process.

52 52 53 CONCLUSIONS

At the moment there is no guidance Equity crowdfunding is an option for from the regulator on compliance, ordinary retail investors, if they are “We are at the beginning of the suitability or appropriateness. We only investing small amounts – the third Industrial Revolution think that peer-to-peer lending does ability to invest with such low entry and the entire financial system look like something that could be levels is the beauty of the crowdfunding is starting to see some core suitable for all kinds of investor, model, the reason why we can praise changes. How much longer INDUSTRY ANALYSIS including ordinary retail investors, it for opening up the asset class to in the right amounts. It’s riskier than many more investors. However, will Alternative Finance be cash and bonds, but with yields so low it’s hard to imagine an adviser ever referred to as ‘Alternative’? these traditional asset classes are not recommending an opportunity to a I suspect not much longer. attractive right now, so an allocation client unless it is something that really to peer-to-peer could make sense. speaks to the client for other, non- Alternative Finance is quickly financial, reasons. The exception to this becoming a crucial part of the We would suggest (again) that the rule might be corporate debentures, best way to achieve this would be wider industry with leading which can offer much lower risk with a diversified portfolio that players such as SyndicateRoom opportunities as they are paid back includes consumer and business over the lifetime of the investment: changing the ‘status quo’ of lending, property and asset backed one reason why many commentators financial services by providing loans, spread across a handful of don’t class them as crowdfunding at the biggest platforms with the most customers with what they all (not the FCA though – it classifies volume and focused on shorter-term want: top quality service.” debentures alongside equity as loans to mitigate interest rate risk. non-readily realisable securities). Picking out individual platforms and Gonçalo de Vascondelos, opportunities could potentially bring SyndicateRoom greater rewards, but we think this strategy would probably be too time consuming for advisers to implement for their customers – it’s equivalent to stock picking instead of investing in funds. For these reasons, advisers may well be more tempted by the closed ended funds that have launched in this space. These funds have ballooned from zero to more than £1.2 billion market cap in just over year, in tandem with the growth of the sector.

54 55 “These mini-bonds and debentures can be used to fund a variety of activities from start-up THE PLATFORMS company funding, to charitable activities, to renewable energy projects"

The following analysis is based upon the different varieties of alternative To put this research together, we carried PLATFORM GROWTH BY THE NUMBERS PLATFORM SUBSECTORS information we have had access to finance, what sort of experience out desktop research to build a register Here we look at the growth in the number of platforms over the last The peer-to-peer sector offers financing thanks to AltFi Data and our own investors can expect and what an of the important details of all of the 10 years. Growth was slow initially, but from 2008 onwards, platforms to individuals (consumers) as well as research. It’s a comprehensive look at investment might look like in terms of platforms, then asked the platforms to have been launching at an accelerated rate. We think that this has been businesses. Looking at just the peer-to- the whole sector, and we’re confident minimum amounts, forecast returns, verify the information we have collected driven by low interest rates, banks’ reluctance to lend as they repaired peer market we see that the majority that we captured data on all of the frequency of returns, fees and term. (we usually get a 50% response rate) their balance sheets and the flexibility that alternative financing provides (48% of platforms) are focused on platforms available in the market at the and (where possible) cross checked our The information we share here should be for its customers – as well as some “me too” platforms setting up. lending exclusively to businesses and time of writing. The intention is to help results against AltFi Data's. enough to allow advisers to get a feel for 34% lend exclusively to consumers. readers understand the size and scale the market before they start to assess of the industry, how it breaks down into individual platforms for themselves. PLATFORM GROWTH AND MARKET SHARE P2P SECTOR SPLIT

100% 100% 100% 100% 5% 5% 3% 2% 2% 120 100% THE PLATFORMS 14% 10% 48% 26% 41% 48% 35% We start by looking at the number of platforms in the market, how they break down between the three major alternative finance 100 32% 80% sectors and what sort of volumes of investment are they able to make. 80 90% 86% 60% 60 68% 60% 63% 66% P2P 55% as at 10 Nov 2015 40% SECTOR LIBERUM ALT FI VOLUME INDEX 40 SPLIT 20% 20 VOLUMES ACROSS THE MARKET 18%

£2,067,358,302 Platforms across the market 0 0% The alternative finance industry has been broadly broken up to three sectors: peer-to- 34% £2,083,587,952 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 peer, crowdfunding, and invoice financing. £664,119,400 P2P Market Share Crowdfunding Market Share £144,942,904 To get an idea of the amount of business these sectors are doing, Liberum and AltFi Alternative Platform Growth Invoice financing Market Share Data track the total amount of funds deployed since the first platform launch in 2005. You can find out more about the index constituents and the criteria for inclusion on its Business Consumer Both website altfidata.com. KEY FINDINGS 18% offer both types of investment. One point to note: AltFi Data classifies debt based crowdfunding as peer-to-business Peer-to-peer have the largest market share (66%) split up by 34% consumer, We suspect that this will be quite a lending. However, for our analysis, we have included debt based crowdfunding platforms 49% business and 18% lending to both fluid picture – as platforms develop within the overall crowdfunding sector. We breakout the debt based crowdfunding their businesses, they may start to The 1st platform launched in 2005 with over 100 platforms launched in the UK to date details and examine them separately where we think it adds something to the analysis. lend to other sectors.

PEER-TO-CONSUMER PEER-TO-BUSINESS INVOICE FINANCING CROWDFUNDING MINIBONDS AND DEBENTURES IN FOCUS Mini-bonds and debentures are debt based investments but investors are These mini-bonds and debentures can purchasing a security rather than making a loan. These investments tend to be used to fund a variety of activities PLATFORMS BY SECTOR be longer term than those of peer-to-peer lending, with the average term of from start-up company funding, to these investments being five years and terms reaching up to 22 years. charitable activities, to renewable energy projects. The risk, return and The advantage of debt based crowdfunding is the ability to receive regular coupon term profiles will vary for each and 60% 30% 8% 2% payments as well as receiving the principal at the end of the term. The majority need to be reviewed individually. of these mini-bonds and debentures (56%) pay on a semi-annual basis, 22% pay PEER- CROWD- DONATION INVOICE TO-PEER FUNDING FINANCING monthly and 22% had payments that varied from investment to investment.

DEBT CROWDFUNDING INVESTMENT TERM: DEBT BASED CROWDFUNDING PAYMENT FREQUENCY: The majority of platforms are peer- but only two are open to online retail financial returns, but backers can 25 22 to-peer lending platforms. Despite investors in the same manner as other receive other forms of incentives, such 20 22% 22% sometimes grabbing more headlines in peer-to-peer platforms). as T-shirts or the opportunity to receive the mainstream media, there are only a first production on a new innovative 15 Differs There are a handful of donation half as many crowdfunding and just two product. We’ve included them here 10 Semi-annually

based crowdfunding websites that Years invoice financing platforms. for completeness, but note that for 5 5 are open to what are called “backers” 3 Monthly the remainder of the analysis, these 5 2 2 (In fact there are already many services instead of investors. Donation based 1 platforms are left out as they do not to provide invoice financing to business, crowdfunding sites may not pay 0 provide a financial return. MINIMUM LOWER AVERAGE MEDIAN MODE UPPER MAXIMUM 56% QUARTILE QUARTILE

56 57 “Obviously equity investments only pay on exit. However the innovation of debt instruments such as corporate debentures and mini-bonds mean that some crowdfunding platforms do offer PERFORMANCE investments with regular interest payments."

It’s the search for higher yields that has driven many investors to alternative finance. Typical returns, and how those returns are paid INVESTMENT TERM INVESTMENT TERM BY SECTOR out, will vary across the different sectors and from platform to platform. Crowdfunding has the longest investment terms in the market at 264 LARI PERFORMANCE TRAILING 12 MONTH RETURN (2006-2015) months or 22 years – although this INVOICE FINANCING was a unique outlier, the investment 6.0% was in a debt based security and the 5.5% underlying assets were renewable energy projects underpinned by feed 5.0% P2B in tariffs, which have an equivalent 4.5% lifespan. Obviously the majority of 4.0% equity crowdfunding projects cannot 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 say when their investors will achieve an exit due to the nature of the investment. P2C The Liberum AltFi Returns Index (LARI) is designed to measure the returns generated from peer-to-peer lending Source: Alt Fi Data (2015) Unsurprisingly, invoice financing has PEER-TO-PEER RETURNS of adverting, this inconsistency could But whether you use the big three or the the shortest maturities as this activity trip up potential investors. smaller, second tier platforms this data is strictly used to create working It is typical of platforms to advertise an suggests that the yields are certainly capital for the firms’ borrowing ACROSS THE annualised minimum level of return, a Another source for assessing returns MARKET respectable. and invoices are (hopefully) paid range of potential returns, or an average is the LARI (Liberum AltFi Date Returns within a matter of months. rate of return. As noted earlier in the Index) which calculates a return based CROWDFUNDING Months 0 10 20 30 40 50 60 report, some platforms have developed upon the performance of the big three Very few equity crowdfunding platforms The peer-to-peer sector comes with investment products that are built around peer-to-peer lenders (RateSetter, Zopa advertise a forecast or targeted rate a larger range of investment terms, Minimum Average Mode Maximum a specific level of return and maturity. and Funding Circle). of return, as outcomes are much anywhere from 6 months to 5 years. Lower Quartile Median Upper Quartile Obviously actual returns vary by each Note that the LARI only looks at the more uncertain with unquoted equity investment, but the advertised forecast big three (which represent over 60% investments. They are more likely to annual rates of return give investors of the market and we expect it to use historical case studies as a way of PAYMENT FREQUENCY and their advisers an indication of what shortly include another two qualifying demonstrating what can be achieved. The can be achieved. platforms, taking its coverage up to exceptions are platforms that crowdfund 80% of the market). Higher yields might debt based securities such as debentures 15% 100% 100% Most of the forecast rates of return are 24% be achievable on some of the smaller and mini-bonds that do have a pay-out 30% clustered between 5-10% per annum. profile. The yield from these investments 44% platforms that have fewer investors. 6% What is interesting to note is that there range from 5-8% and some are fixed and 35% 61% 5% 60% 3% 6% is very little variation between the peer- We can see from our research that the some are variable. It is still a small section 5% to-business and the peer-to-consumer average forecast annual yield is nearly of the market though, and there aren’t 2% 5% sectors. 9%, much higher than what the actual enough data points to do much analysis. ACROSS P2B P2C CROWDFUNDING INVOICE data from LARI is telling us, or the 6% However, what may not be obvious THE MARKET FINANCING we feel can be achieved. here is whether or not these targeted On realisation Differs Annually Semi-annually Quarterly Monthly returns are calculated net of fees, taxes or default rates. In fact, we took a look ADVERTISED FORECAST ANNUAL RATES OF RETURN 15% 15% 15% PAYMENTS TO INVESTORS at how each platform calculated their 16% rates of return and found that 49% are Payment profiles differ. Some platforms pay income monthly, quarterly or semi-annually and some only pay on exit. gross of fees and charges, while only 14%

10.9% Obviously equity investments only pay on exit (or if the investee firm starts paying a dividend, which is very unlikely for these early 11% 16% were net, and the remaining 35% 11% 12% 10%

8.97% stage companies). However the innovation of debt instruments such as corporate debentures and mini-bonds mean that some either did not advertise a forecast rate 9.1% 9.2% 9% 9% crowdfunding platforms do offer investments with regular interest payments. of return or did not clarify whether it 10% 7% was net or gross. As each platform will 6.2% Invoice financing only pays out on maturity, however, as seen earlier, these are short term – only ranging from 1 to 6 months.

8% 6% 6%

have differing fee structures and ways 4.5% 5% 3.95% 5%

6% 4% LARI PERFORMANCE KEY FINDINGS 4% ABSOLUTE RETURN CHANGE There is very little to distinguish the The LARI (based on actual, achievable, Investment terms can range 2% returns quoted by peer-to-consumer returns) shows an absolute return of anywhere from 1 month in invoice 3 MONTH 1.62% +0.01 and peer-to-business lenders 5.45%, much lower than the platforms’ financing to 264 months in debt based 0% own forecasts, demonstrating the crowdfunding 1 YEAR 5.45% +0.05 MINIMUM LOWER AVERAGE MEDIAN MODE UPPER MAXIMUM problem of platforms using different QUARTILE QUARTILE 3 YEAR 18.05% -0.03 calculation methodologies Across the Market P2C P2B Source: Alt Fi Data as of 30 September 2015

58 59 TR ANSPARENCY THE CONSUMER JOURNEY

FCA AUTHORISATION TRANSPARENCY TRADE BODY MEMBERSHIP BY PLATFORMS The alternative finance industry The FCA policy statement 14/04 Most crowdfunding platforms are either Mini-bonds are an interesting 100% required all peer-to-peer platforms directly authorised or are the appointed conundrum in terms of regulation. presents itself as being fairer, more P2PFA democratic and more transparent to seek FCA Authorisation. Happily, of representatives of authorised firms. While they are not regulated by the FCA, UKCFA 79% all the platforms we looked at in our 90% of platforms across the market they can be listed on a stock exchange, that mainstream financial services. 80% research only two were not authorised were directly authorised by the FCA. which will have its own rules and This is a hard claim to measure and 69% None 67% by the FCA - and this was not the result regulations to list. However, they tend substantiate, but we’ve looked at Note: for the purposes of our analysis, of platforms trying to sneak in under to be small exchanges such as the Irish a handful of indicators here. 60% 55% we have considered interim permissions the radar! One platform was still in Stock Exchange where the regulations 50% 50% to be the same as authorised. Interim TRADE ASSOCIATIONS beta testing and we assume they were may be less robust than the more 38% permissions are a temporary measure 40% seeking authorisation, while the other mainstream markets. There are two major trade associations 33% to give platforms time to comply platform was for Bitcoin investors that operate in the UK, the Peer-to-Peer 26% with the requirements of full FCA Invoice financing falls under asset- and was therefore outside the FCA's Finance Association (P2PFA) and the 17% authorisation. backed securities; this is not currently a 20% perimeter - for the moment at least. UK Crowdfunding Association (UKCFA). regulated activity by the FCA. 10% 10% These associations aim to bring greater 4% credibility to the sector and set out best 0% 0% 0% FCA AUTHORISATION practice regulations that their members 10% 5% 4% 12% must adhere to. Their regulations are ACROSS P2B P2C CROWDFUNDING INVOICE 90% 95% 96% 88% 100% THE MARKET FINANCING more stringent than those already set 95% 96% out by the FCA and UK Government. due to the nature of their activities, so 86% ACROSS CROWD- INVOICE unlike P2P platforms they only have LIBERUM ALTFI INDICES P2B P2C Successfully applying for membership THE MARKET FUNDING FINANCING one option). The UKCFA is designed of the P2PFA means going through for a range of business types in the 28% a lengthy application process to alternative finance sector, so its code 72% ACROSS demonstrate how the platform meets of practice is much more broadly THE MARKET the key requirements set out by its Yes No written. The association promotes a Operating Principles. These principles COMPARISON TO BANK ACCOUNT & CALCULATION OF FORECAST RETURNS professional, transparent and consumer cover areas such as management, KEY FINDINGS driven industry. Those wishing to Some peer-to-peer platforms have previously explicitly compared themselves to a capital requirements and IT systems, Trade associations hold their become members need to agree to 33% bank account, drawing the ire of the FCA. Peer-to-peer lending is not lending the same among other things. Some members member to even more stringent its code of conduct as well as pay an as a bank account – the risk of bad loans lies directly with the lender, as opposed to have also made their loan books 67% P2B regulations than the FCA annual fee to cover the lobbying and the bank – so it’s good to see that this misleading comparison has been expunged available to their registered users. promotional costs of the association. from the marketing efforts of the platforms. We looked at the loan books of the All platforms that were required to seek FCA authorisation did so “big three” in another section, but One invoice financing platform has 49% of platforms calculate their forecast returns gross of fees and charges (and five platforms that are members decided become a member of the P2PFA possibly taxes and expected rate of default), while only 16% were net. The remaining 49% of platforms stated returns of the P2PFA currently make their (there are only two invoice financing 25% 35% either did not advertise a forecast rate of return or did not clarify whether it was gross of fees and 16% net of fees loan books available. It may be that platforms in total at the time of writing). P2C net or gross. their rigorous criteria have put off INCLUSION IN THE 75% potential members; we found that LIBERUM ALTFI INDEX only 10% of peer-to-business and THE CONSUMER JOURNEY LENDER VERIFICATION 17% of peer-to-consumer platforms The Liberum AltFi Indices increase the REGISTRATION 100% were registered with the P2PFA. In transparency of the sector by tracking 15% 6% 10% addition, the UKCFA has attracted 26% the growth of the UK industry since After deciding which platform to invest 90% 97% 100% of peer-to-business platforms and its inception. However, there are CROWDFUNDING with, the first step is to register. Typically 80% 85% 4% of peer-to-consumer platforms. strict criteria for inclusion: platforms this is as easy as setting up a Facebook 70% 43% There has been one high profile exit must have a cumulative origination account – you fill in your name, email 60% from the P2PFA: Wellesley & Co left in volume of greater than 0.1% of the total and a few other details. However, the November 2014 due to differences over index. These tight inclusion criteria PS14/4 regulations for investment based 50% 100% 57% 94% 90% Wellesley & Co's marketing strategy. mean that only 28% of all platforms crowdfunding require platforms to 40% are included in these indices. INVOICE verify if consumers are either a HNW The crowdfunding sector is much 30% FINANCING or sophisticated investor, or a retail smaller, but an overwhelming 67% This analysis shows us that there investor who will certify that either: 20% are members of the UKCFA. (Note is a "long tail" of platforms who do 10% that crowdfunding platforms are not not originate very much business. they won’t invest more than 10% of 3% eligible for membership with the P2PFA Included Not included their net investible assets, 0% ACROSS P2B P2C CROWDFUNDING INVOICE or that they are receiving advice. THE MARKET FINANCING Basic KYC Additional Certification of Investor Category

60 61 36% 41% 17% 27% 100% YES CHARGES ACROSS THE CROWD- INVOICE P2B P2C AND FEES NO MARKET FUNDING FINANCING TO LENDERS COMPARING THE BIG THREE

This is usually a simple check box. The majority of peer-to-peer platforms promotions for these investments for 12 Where charges are applied to lenders, Registration is quick and simple when only require a KYC (know your client) months after the date of the statement. there is not one single charging KEY FINDINGS compared to many other investments. check, to comply with money laundering PS14/4 states that firms can integrate model that has been adopted by the 57% of platforms require investors to fill in a KYC check either when the This is of course a blessing and a curse regulations. However, crowdfunding client certification and appropriateness platforms. register or before they make their first investment and the remaining 43% require – it’s a genuine consumer benefit that platforms are all required to verify which test requirements if they wish, but to Annual fees charged on the total loan to certify what category of investor they fall into helps democratise investing, but does category of investor their members remain compliant there only needs to be amount lent are common and are Minimum investments from as little as a penny to £65,000 make it easier for unwary investors to fall into and those retail investors a valid statement in place at the time of around 1% per annum across the whole quickly get out of their depth and make should sign a Restricted Investor communicating the promotion. We found Only 41% of platforms offer a secondary market, but we expect to see this market. Commission or selling fees are mistakes. Statement which will allow the platform that 97% include a certification test step figure increase within the next 12 months charged on loans sold on the secondary to communicate direct offer financial upon registration or before investment. market, and range from 0.25% to Only 36% of platforms charge investors a fee 1.5%. They are charged on either the MINIMUM INVESTMENTS amount left outstanding on the loan or MINIMUM INVESTMENTS (2015) The lowest minimum investment level on the original investment amount. In required across the whole market is only MIN. 1Q. AVERAGE MEDIAN MODE 3Q. MAX. the equity crowdfunding and invoice a penny, but can be as high as £65,000! financing sectors there are a few Zopa’s story is the most straightforward – for 10 years, it has lent to consumers on an unsecured basis This wide variation reflects the differences ACROSS platforms that charge a performance (it has done a small amount of lending to sole traders, but this is classified as consumer lending here). £0.01 £20 £3,450 £100 £100 £1,000 £65,000 in the models they platforms use and the THE MARKET fee on profits, which range from 7.5% to type of investors they are focused on. 15% for crowdfunding and 10%-30% for 100% 90% P2C £0.01 £10 £3,557 £25 £10 £5,000 £25,000 invoice financing. 80% Invoice financing is a small sector 70% 60% with only two platforms at the time of 50% P2B £0.01 £25 £4,581 £100 £100 £1,000 £65,000 writing, and these particularly focus on COMPARING THE BIG THREE 40% 30% HNW/sophisticated investors. To even This analysis was produced by AltFi Data 20% EQUITY in April 2015 and is a comprehensive 10% open an account, investors will need a £1.00 £10 £782 £100 £10 £1,000 £5,000 0% 11Q2 11Q3 11Q1 11Q4 12Q2 12Q1 12Q3 13Q2 13Q1 15Q1 13Q3 07Q2 10Q2 07Q1 07Q3 12Q4 14Q2 10Q1 10Q3 14Q1 14Q1 14Q3 13Q4 05Q2 07Q4 05Q1 05Q3 08Q2 09Q2 10Q4 08Q1 06Q2 08Q3 09Q1 09Q3 06Q3 06Q1 05Q4 08Q4 09Q4

CROWDFUND 06Q4 minimum £50,000 (although this is not analysis of the loan books of the big how much they will need to commit three peer-to-peer lending platforms – consumer - unsecured DEBT £5.00 £5 £849 £100 £5 £1,000 £5,000 Zopa, Funding Circle and RateSetter. to one investment - the minimum CROWDFUND investment is around £700). This kind of analysis is only possible because they are prepared to publish If we then look at RateSetter, for the first 11 quarters of its lending, RateSetter lent exclusively to consumers their loan book data – anybody can on an unsecured basis. Then in mid-2013, the platform began to lend to consumers on a secured basis and LIQUIDITY OF INVESTMENTS has subsequently branched out into secured and, most recently, unsecured business lending. access this by downloading the data The data we‘ ve collected shows that 59% of the plat forms do not currently have secondar y markets for investors to sell their investment, in CSV format from their websites. 100% though many are developing secondary markets. Active secondary markets are a consideration for alternative finance and we expect 90% We can only applaud this level of the number of secondary markets to increase moving forward. However, just because a market exists does not mean that it will be 80% transparency. It’s not something that 70% deep enough and liquid enough to guarantee an exit for investors at a price they feel is fair. And (as with any market) the real test for 60% you would ever see from the banks, 50% liquidity will come when large numbers of investors want to exit at the same time. Note that invoice financing platforms do not operate 40% and it's data that helps investors 30% secondary markets, but the assets return to cash very quickly anyway. 20% understand how their money is lent. 10% 0% 41% 59% 58% 21% 0% As the risk of default sits with the 10Q3 10Q4 11Q1 11Q2 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 13Q1 13Q2 13Q3 13Q4 14Q1 14Q2 14Q3 14Q4 15Q1 investor (unlike the banking model), it business - secured business - unsecured consumer - secured consumer - unsecured seems reasonable to let investors have access to this sort of information.

The rest of the analysis and charts in this section were produced by AltFi Data: This diversification trend can also be seen inFunding Circle’s lending. The platform initially lent solely ACROSS P2B P2C CROWDFUNDING INVOICE THE MARKET FINANCING " The key theme that we found as we to businesses on an unsecured basis but secured lending is becoming an increasingly large part of its examined the trends in loan origination business, with 15% of last quarter’s lending being secured. The vast majority of this growth is driven by Funding Circle’s expansion into property backed lending. is diversification – platforms are evolving CHARGES AND FEES wishing to list on the platform (just Of course, the platforms have to make and maturing, lending different types 100% like "free" current accounts). Overall money, and their fees and charges have 90% Another advantage this sector has of loan to different types of borrowers 80% only 36% of platforms listed on our to be applied somewhere – we think 70% over traditional lending institutions is at a greater range of rates. This isn’t register currently charge any type that the key metric to look at here is 60% the low overhead costs of an online surprising, we probably didn’t have to 50% of fee to investors. Interestingly, the the difference between the lender and 40% marketplace; this allows platforms do this analysis to know that, but exactly 30% platforms that list business investment borrower rate, not how that is divided 20% to charge lower fees or no fees at all how this evolution and diversification 10% opportunities were more likely to charge between the two parties – it’s the 0% to investors. Its common practice for is taking shape in each platform is fees to lenders, perhaps reflecting more difference between the two that tells 10Q3 10Q4 11Q1 11Q2 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 13Q1 13Q2 13Q3 13Q4 14Q1 14Q2 14Q3 14Q4 15Q1 some or all of the charges to get passed interesting to observe and they are work involved in sourcing deals and you how much the platform is charging onto the borrowers or companies not all moving in the same direction. business - secured business - unsecured carrying out due diligence. for its services.

62 62 63 “The transparency that they create in publishing these loan books is virtually unprecedented “"All the platforms have remarkably stable lending rates since RateSetter and Funding and will hopefully enable investors to better understand the asset class and enable enlightened Circle entered the fray in 2010" AltFi.com investment decisions to be made"

From their websites, one can gather Those of you who are familiar with the that Funding Circle lends to businesses rates that Zopa and RateSetter offer whilst RateSetter and Zopa lend mainly their lenders may be surprised to see 12 100% to consumers. We’ve looked at who the Zopa’s mean lending rate higher than platforms have been lending to each 90% "RateSetter’s, (as RateSetter currently 10 origination quarter since they launched. 80% offers lenders about 150bps more yield than Zopa on its 5yr rate). However this is To get a feel for the riskiness and diversity 70% 8 explained when we look at the term of the of the lending of each platform, we looked 60% loans which makeup the loan books with at the weighted average interest rate 6 50% RateSetter’s loan book being weighted that lenders received after platform fees 40% towards shorter term loans which will and any contingency fund fees. It must tend to have lower yields. Taking a closer be noted here that a direct comparison 4 % of Zopa Loanbook 30% look at the terms of the loans in each of the absolute level of this lending rate 20% origination quarter, it can be seen that between platforms is not useful because 2 10% all platforms started by making shorter of things like differing default rates and

Weighted Average Lending Rate - net of fees (%) 0% loans and then moved into making the existence of contingency funds or not. 0 longer duration loans. Funding Circle 11Q2 11Q1 11Q3 11Q4 12Q2 12Q1 12Q3 13Q2 15Q1 13Q1 13Q3 07Q2 10Q2 07Q1 07Q3 12Q4 14Q2 10Q1 10Q3 14Q1 14Q3 13Q4 05Q2 07Q4 05Q1 08Q2 05Q3 09Q2 10Q4 06Q2 08Q1 08Q3 14Q4 09Q1 09Q3 06Q3 06Q1 05Q4 08Q4 09Q4 However, comparing the trends in lending 06Q4 11Q2 11Q1 11Q3 11Q4 12Q2 12Q1 12Q3 13Q2 15Q1 13Q1 13Q3 07Q2 10Q2 07Q1 07Q3 12Q4 14Q2 10Q1 10Q3 14Q1 14Q3 13Q4 05Q2 07Q4 05Q1 08Q2 05Q3 09Q2 10Q4 06Q2 08Q1 08Q3 14Q4 09Q1 09Q3 06Q3 06Q1 05Q4 08Q4 09Q4 06Q4 has had a surprisingly stable term rate between platforms is possible. Origination Quarter Origination Quarter composition of its lending over the last Under 13 months 13-36 months 37-48 months 49-60 months All the platforms have remarkably stable 2 years. We can see opposite trends, lending rates since RateSetter and Funding however in the Zopa and RateSetter loan Circle entered the fray in 2010. Prior to books with Zopa’s proportion of longer 12 2010, it is interesting to observe Zopa’s 100% loans increasing whilst RateSetter’s lending rate increase in the 2008/2009 90% proportion of shorter loans is increasing 10 period as the credit crunch set in. 80% - diverging strategies from the UK’s top two peer-to-peer consumer lenders. As a measure of the diversity of 70% 8 interest rates on loans made within the 60% This article barely scratches the surface origination quarter, we have marked of what can be done with the information 6 50% the standard deviation for each point that Zopa, RateSetter and Funding 40% on the chart. One standard deviation Circle provide. The transparency that 4 includes 67% of the population. The 30% they create in publishing these loan bigger the standard deviation, the % of RateSetter Loanbook 20% books is virtually unprecedented and more diverse the lending rates are. 2 will hopefully enable investors to better 10% understand the asset class and enable

A larger range of lending rates could Weighted Average Lending Rate - net of fees (%) 0% 0 enlightened investment decisions indicate a larger range of borrower 10Q3 10Q4 11Q1 11Q2 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 13Q1 13Q2 13Q3 13Q4 14Q1 14Q2 14Q3 14Q4 15Q1 10Q3 10Q4 11Q1 11Q2 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 13Q1 13Q2 13Q3 13Q4 14Q1 14Q2 14Q3 14Q4 15Q1 to be made. For our part, we’ll keep quality (as one would expect lending rate Origination Quarter Origination Quarter crunching the data and writing about to be reflective of borrower quality). It is Under 13 months 13-36 months 37-48 months 49-60 months what we find – so watch this space…" interesting to note that the lending rate standard deviation of all three platforms has increased over time. This indicates a 12 100% diversification of the loan books and could be as the platforms offer riskier loans to 90% 10 investors as their credit models are refined. 80%

Funding Circle, for instance, has introduced 70% two new risk bands at the lower end of the 8 60% credit spectrum since it began lending. 6 50% Perhaps the most surprising observation 40% about these charts, however, is the large 4 increase in standard deviation seen 30%

in Zopa’s loan book over the last two Loanbook Funding Circle of % 20% 2 years. The timing of this coincides with 10% the introduction of Zopa’s Safeguard Weighted Average Lending Rate - net of fees (%) 0 0% fund. This could indicate a change in 10Q3 10Q4 11Q1 11Q2 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 13Q1 13Q2 13Q3 13Q4 14Q1 14Q2 14Q3 14Q4 15Q1 15Q2 10Q3 10Q4 11Q1 11Q2 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 13Q1 13Q2 13Q3 13Q4 14Q1 14Q2 14Q3 14Q4 15Q1 lending strategy as Zopa attempts Origination Quarter Origination Quarter to maintain its pace of growth. Under 13 months 13-36 months 37-48 months 49-60 months

64 65 “The level of information does potentially mean that stock pickers can identify opportunities to DEFAULTS outperform."

The Peer-to-Peer Finance Association (P2PFA) is one of the trade associations for the alternative finance sector. In addition to DEFINITIONS SUMMARY OF DEFAULT RATE INFORMATION CONCLUSIONS representing the industry, it provides a set of standards of which members must follow. Among these rules members must use the The following are the definitions P2PFA standard, which allows for comparable and meaningful statistics for platform default rates. We’ve summarised the published laid out by the P2PFA The information here gives a good To be honest, we’ve only scratched information in the table below (the data is as of November 2015): top level view of the platforms, and the surface of what is possible with Non-Performing Loan (or in Arrears): we think it may be satisfactory if your the loan book data. If and when

PLATFORM 2015 More than 45 days overdue in objective is to select a platform. A other lenders reach the same size 2010 2011 2012 2013 2014 (Jan - Nov) interest payment; or key metric might be the expected as the big three and also make their More than 45 days overdue with rate versus the actual rate. loan books available, it will mean ARREARS 0.0% 0.0% 0.002% 0.009% 0.02% 0.017% that there is an extraordinary level principal repayment; or Investors who want to be more active of data available to retail investors to EXPECTED DEFAULT RATE 1.4% 1.4% 1.4% 1.54% 2.486% 2.206% Legal action for enforcement of the by picking their loans may want to help them assess the performance loan has commenced; or delve deeper into their loan books and ACTUAL DEFAULT RATE 1.812% 0.634% 0.914% 1.392% 1.646% 0.544% of the platforms. How many of examine the variation in default rates The loan is being or has been them have the time and inclination by investment terms, credit rating and ARREARS 0.0% 21.82% 1.02% 2.65% 1.14% 1.11% renegotiated with a borrower, or to examine the data is another interest rates on offer – among other The loan has not otherwise been in question, but the intentions behind variables. The level of information does EXPECTED DEFAULT RATE 0.0% 0.07% 6.77% 1% 0.66% 1.48% full compliance. The amount of arrears is this initiative must be applauded. potentially mean that stock pickers can the amount overdue for payment in the For those who don’t want to dive ACTUAL DEFAULT RATE 0.0% 0.07% 11.33% 1.37% 2.74% 3.28% identify opportunities to outperform. first two cases above. into the data, the LARI is a useful The move to standardise default rate indicator of top level performance. ARREARS 0.0% 0.4% 0.9% 0.2% 0.0% 0.0% Capital Losses (Default): reporting makes it easier to compare Any portion of a loan that has not EXPECTED DEFAULT RATE 3.2% 3.3% 4.2% 4.5% 4.6% 3.7% platforms and we expect that more been repaid, 120 days following the meaningful comparisons will be original loan repayment date; ACTUAL DEFAULT RATE 4.0% 5.5% 3.7% 3.3% 1.2% 0.3% drawn out as the platforms mature. All costs incurred by the lender in ARREARS N/A N/A N/A N/A 0.0% 0.0% relation to the enforcement of a Non-Performing Loan, where such costs SURVEY RESULTS EXPECTED DEFAULT RATE N/A N/A N/A N/A 0.1% 0.10% are not recovered in full from the With all of our previous Industry relevant borrower; Reports we have conducted a survey ACTUAL DEFAULT RATE N/A N/A N/A N/A 0.0% 0.0% Any loan amount where there is a of the main market participants ARREARS N/A N/A N/A N/A 0.01% 0.01% reasonable expectation that the - including financial advisers, borrower is not going to repay the loan wealth managers, professional EXPECTED DEFAULT RATE N/A N/A N/A N/A 1.54% 1.54% on the original repayment date (i.e. intermediaries and investment theborrower has gone bankrupt etc.) providers, and platforms. ACTUAL DEFAULT RATE N/A N/A N/A N/A 0.29% 0.0% Members are required to report on The adviser survey for this report ARREARS N/A N/A N/A 0.0% 0.0% Not Provided a 12 monthly calendar basis (January posed us with a big challenge to December) the following: collecting responses as advisers EXPECTED DEFAULT RATE N/A N/A N/A 0.88% 0.0% Not Provided have little to no (most likely no!) • Actual arrears (as a percentage of experience in this sector. ACTUAL DEFAULT RATE N/A N/A N/A 0.0% 0.0% Not Provided all outstanding balances from loans made in the calendar year of the loan) However, our intention was to build a ARREARS N/A N/A N/A N/A 0.0% 0.9% • Expected defaults (as a percentage picture of what efforts the alternative of lifetime default rates of amount finance market have made to engage EXPECTED DEFAULT RATE N/A N/A N/A N/A 1.5% 1.5% lent in the calendar year of the loan) advisers and how much advisers understand alternative finance – so • Actual defaults (a percentage of ACTUAL DEFAULT RATE N/A N/A N/A N/A 0.0% 0.0% even negative adviser responses the total lent by the platform in gave us important data points. ARREARS N/A 0.0% 2.61% 1.41% 2.04% Not Provided the calendar year of the loan).

EXPECTED DEFAULT RATE N/A Not Provided Not Provided Not Provided Not Provided Not Provided

ACTUAL DEFAULT RATE N/A 0.0% 0.14% 0.09% 0.0% Not Provided

ARREARS Not Provided 0.31% 0.08% 0.02% 0.03% 0.02%

EXPECTED DEFAULT RATE Not Provided 2.01% 1.5% 1.41% 2.30% 2.81%

ACTUAL DEFAULT RATE Not Provided 0.96% 0.78% 0.55% 0.61% 0.13%

66 66 67 ADVISER SURVEY “At the moment, financial advisers are not being asked about alternative finance by their clients"

We had a total of 130 responses, from firms ranging in size from sole traders to a team of 35, and assets under management Q. Which of these have clients Q. Would you recommend clients Q. Would you personally invest in: of £9 million to £500 million – so we believe we have captured a good representation of the adviser market. enquired about over the last 12 invest in: The survey consisted of 16 questions and took most respondents less than 5 minutes to complete. months? 10% 52% 48% 41% 59% Q. Are you aware of the following types of online alt fi platforms?

Over half of advisers were aware of the different types of alternative 67% 63% 60% 57% finance. Peer-to-business lending gets the most recognition (67% had heard of it) and invoice financing has

P2P P2P EQUITY INVOICE the lowest level of awareness (57%). PEER-TO-BUSINESS PEER-TO-PEER LENDING PEER-TO-PEER LENDING BUSINESS CONSUMER CROWDFUNDING FINANCING 10% 7% 56% 44% 48%

Q. Are you aware of the following alternative finance models? 44%

35% 33% 30% 27% 23% 25% 20% 15% 13% 13% 10% 5% PEER-TO-CONSUMER CROWDFUNDING CROWDFUNDING 0% 7% 78% 22% 30% 70% INVESTMENT INVESTMENT INTO CO-INVESTING INTO EQUITY A CONTINGENCY CO-INVESTMENT INTO INTO CORPORATE RETAIL/MINI-BONDS, WITH EXPERIENCED BUSINESS FUND FOR BAD LOANS ALONGSIDE DEBENTURES BOTH LISTED AND ANGEL INVESTORS, ON THE DEBTS THE PLATFORM'S OWN UNLISTED SAME TERMS AS THEM CAPITAL However, once we got beyond the headlines and started asking questions about the different operating models and investment options, levels of awareness dropped significantly. Investment into corporate debentures (33%) scored the highest – perhaps surprisingly as they are such a small part of the alternative investment universe, but we can speculate that the advisers we surveyed had come across them via more conventional investment channels. Only a small number of advisers were aware CROWDFUNDING INVOICE FINANCING INVOICE FINANCING of significant risk-mitigants, such as contingency funds in peer-to-peer lending and co-investment in crowdfunding. 0%

Q. Are you aware of the following? Not in the Possibly in Now Not in the Possibly in Now foreseeable the future foreseeable the future future future 70% 60% 60% 59% would possibly invest in P2P 50% None of the respondents currently 40% lending in the future, but 41% stated 40% recommend investing in alternative 30% that they would never personally invest 17% 17% finance to their clients. 20% in this sector. 7% of advisers already 10% 7% 10% 3% INVOICE FINANCING However an encouraging 48% and 44% invest in crowdfunding personally, with 0% would possibly consider recommending a further 48% prepared to consider it The government is Certain alt fi The government has A index of peer to High street banks are Alt fi platforms are Institutions are Clients have inquired about clients to invest in the future in peer- in the future. Invoice financing was the this over the last 12 months consulting on the investments may be deployed money to peer lending returns referring business to regulated by the FCA investing via alt fi to-peer lending and crowdfunding least popular sector, with 70% stating inclusion of alt fi in allowable in SIPPs SMEs through alt fi is available alt fi platforms platforms respectively – we can conclude that they would never consider it – but bear ISAs platforms a significant portion of advisers are in mind that this sector also had the Only a small portion of advisers have understandably cautious and want to lowest levels of awareness. Perhaps Unsurprisingly, more advisers (60%) were aware of the headline grabbing news around peer-to-peer ISAs, and a significant minority had their clients speak to them about wait and see how the sector develops, advisers have had bad experience (40%) were aware that it was SIPP acceptable – possibly due to their familiarity with SIPPs. However, the vast majority of advisers alternative finance in the past 12 months. but they retain an open mind. getting their own invoices paid? in our sample were not aware of some of the key milestones (and signs of a maturing sector) that the alternative finance industry has achieved to date. Most striking was the discovery that only 7% of advisers realised alternative finance was now regulated. If Q. Are you aware that some alt fi platforms specialise in the following areas the alternative finance industry wants to engage advisers, then there is a lot of work to do to educate them about the sector.

Q. Do you expect alternative finance to fall within your advice process in the next 12 months? 50% 50% 47% 40% 20% 3% Despite the pending introduction of the peer-to-peer ISA within coming months, only a small portion (9%) of respondents felt that this sector would fall within their advice process within the next 12 months. This result chimes with the one to the right – at the moment they are not being asked about alternative finance by their clients. PROVIDING FINANCE ETHICAL/SOCIAL RENEWABLE PROVIDING REGIONAL FUNDING STUDENT FOR PROPERTY IMPACT INVESTMENTS ENERGY MORTGAGE INVESTMENT LOANS/EDUCATION This was a qualitative question designed to help us understand what is holding the advisers back from participating in this sector. DEVELOPMENT PROJECTS FINANCE There were several responses calling for greater regulatory requirements and increasing research on the sector, and several responses were clear that no change would make them likely to recommend alternative finance at any point in the near future. There were higher levels of awareness that the platforms specialised in different markets.

68 69 “40% of our sample would like to know more and be able to speak knowledgeably about alternative finance to their clients" PLATFORM SURVEY

Q. How much money do you think has been invested in peer-to-peer lending in the UK? The survey comprised of 8 questions and we had responses from 15 platforms, Q. What is your estimate of how including all of the biggest, top tier platforms operating in the UK. many funds the UK financial advice 27% 12% 12% 12% community has under its control? 19% 19% They survey was designed to get a feel for how platforms are currently interacting with advisers, how well they understand the adviser community and what (if any) 15% plans they had to develop distribution through advisers. We also asked questions to help us get a better understanding of factors affecting investors - such as secondary markets and institutional investment.

Less than £1bn £1bn - £1.5bn £1.5bn - £2bn £2bn - £2.5bn £2.5bn - £3bn Over £3bn Q. What do you think are the biggest barriers that prevent advisers from recommending alternative finance investments? According to AltFi Data, cumulative lending for peer-to-peer lenders has reached over £4 billion in the UK. Only 12% of respondents Less than £250bn answered correctly, while many (27%) seemed completely unaware of the scale of the peer-to-peer lending market. Lack of awareness and education was thought to be the biggest barrier for advisers by most platforms. Regulations and concerns over compliance were a close second. 8% Q. How much money do you think has been invested in crowdfunding in the UK?

41% 32% 0% 9% 0% 18% Q. Do you currently market your platform to financial advisers? If not, do you plan to in the future?

73% of platforms either already market to financial

advisers, or plan to in the future. What form this marketing £250bn - £400bn will take remains unclear, but based on our adviser survey 73% (and the platforms’ responses to the other questions) 38% Less than £1bn £1bn - £1.5bn £1.5bn - £2bn £2bn - £2.5bn £2.5bn - £3bn Over £3bn there will have to be a big educational effort to break down the educational barriers that are keeping many Just over £118 million has been invested through crowdfunding in according to AltFi data. advisers from participating in the market.

Q. Would you like to be in a position to speak knowledgeably to your clients about alt fi in the next 12 months? Q. Have you received any investments from institutional investors? 40% of our sample would like to know more and be able to speak knowledgeably about alternative finance to their clients. Bearing in £400bn - £550bn mind the results above, this is not necessarily with a view to making a recommendation, but whatever advisers think about the merits of the asset class, it makes sense to be able to discuss it knowledgeably. 15%

73% of the respondents have seen institutions invest via their platforms. This may * OTHER SURVEYS reflect our sample, which was heavily weighted to the largest peer-to-peer lending There have been some other surveys of adviser attitudes to alternative finance. PollRight found that 70% of financial advisers platforms, who have received the most institutional investment to date. foresee increased client risk appetite, while 45% believe the new ISA rules will ramp up interest in peer to peer lending.

£500bn - £700bn Yorkshire Building Society found that just 4% of advisers had invested in the peer-to-peer space, while a further 14% would If yes, approximately how much? consider investing. The remainder, over 80%, wouldn’t invest in the space, for now. Some platforms were not willing to disclose this information. Among those that did 23% respond answers ranged from as little as £100,000 to £20m and we know that on the biggest platforms it is much larger than this. CONCLUSIONS Based on the results from our sample, It is impossible to escape the conclusion However, we do think that a longer track it appears that advisers have not really that a lack of knowledge about the record for alternative finance, wider looked beyond the headlines that have different operating models, the take-up from the public and greater been written about alternative finance innovations like contingency funds awareness of developments within the Over £700bn in the mainstream press. While more and developments such as regulation industry will start to see advisers move

than 60% of them had heard of the three all contribute to advisers’ reluctance from being sceptical, to being interested, It’s estimated that there is £590 billion in main areas of alternative finance (peer- to participate. But we will resist the and then finally to being engaged. assets under the influence of advisers. 38% to-consumer lending, peer-to-business temptation to over-egg this: alternative of platforms put the figure at just a little less lending and equity crowdfunding) and finance remains a new asset class than this, between £400bn and £550bn and were aware of the consultation on and heavily regulated advisers are 15% were in the right bracket. Platforms seem including peer-to-peer lending in ISAs, instinctively cautious - this will be as to have a good understanding of the size of there was little awareness of the details much a part of their reluctance as any the opportunity in the advised distribution channel. beyond this. lack of knowledge.

70 70 71 “...the secondary markets are not very deep, and that investors should not rely on them as an easy exit route for the moment" INVESTOR SURVEY

There has already been a lot of research important factors that would change into investors’ levels of awareness of their mind were better returns (72%), MONEY LENT BY INDIVIDUAL alternative finance and several surveys more transparency and understanding LENDERS: of investors’ have already been done. about where their money is going Nesta surveyed 630 lenders on Funding We’ve summarised them here. (62%) and if they could receive better Circle in April 2013. guidance on how to use the different In 2013 Nesta and the University of platforms (62%). Cambridge surveyed 2,000 individuals Q. If you operate a secondary Q. When advertising a likely return to Q. How many investments have and found that 58% of those were Wellesley & Co. carried out a survey of marketplace, approximately how potential investors, do you take into you had that have been made on aware of at least one form of alternative over 2,000 people in 2014 that revealed 42% 10% many loans or loan parts are sold account: the recommendation of a financial finance, but those that used alternative several key trends within the peer- each month and what is the value adviser (that you are aware of)? finance was still relatively low. In fact, to-peer lending market. The average of your monthly transactions in the only 14% of those that were aware of amount invested is £2,717, with men < £1,000 £1,000-2,000 secondary marketplace? The majority of respondents said zero, Fees alternative finance actually invested in it typically investing more than women but on the positive responses the 38% 37% 38% - the majority via donation/reward based (£3,432 vs £1,748). The survey also Very few respondents chose to answer Expected numbers ranged from two to over 100 Default Rates crowdfunding or peer-to-peer consumer highlighted three key changes that would this question fully. Of the responses investments and one respondent stated lending platforms. cause current peer-to-peer investors to we did receive, the numbers ranged None that 25% of all investments made on its increase their investments – inclusion 6% 41% from 30 to 150 loans or loan parts 25% platform were at the recommendation 60% of all respondents believed they within an ISA (47%), better interest rates each month, with values from £1,000 of a financial adviser. It is encouraging were "unlikely" or "very unlikely" to (47%) and clearer regulation (34%). Those to £75,000 a month. Answers were to see that some platforms have had the begin or to continue using an alternative This question is designed that did not already invest in peer-to- £2,000-3,000 > £3,000 very sparse and we do not feel this interaction with advisers already and finance platform in the near future. to gauge transparency – are peer lending felt similarly, with clearer is a meaningful data point – and of although numbers are small, the market 56% felt that alternative finance was platforms’ communications “clear, regulation (19%) and better interest Source: Nesta (2013) course the numbers above are only is growing and new developments with too risky. Respondents that were aware fair and not misleading”? rates (21%) the key changes that would Here we see that the majority investors are really relevant in the context of the ISAs and SIPPs should slowly encourage of alternative finance but who had not make investment more attractive. contributing less than £1,000 (42%) or greater total size of the respondent’s market. Our view is that platforms should be more advisers to get involved. invested to date stated the three most than £3,000 (41%) Our assumption is that the low level of stating expected returns net of fees responses indicates that the secondary and forecast default rates, but this PERCENTAGE OF FINANCIAL WEALTH LOANED THROUGH FUNDING CIRCLE markets are not very deep, and that is not standard practice. Only 25% 70% investors should not rely on them as of respondents take into account Over 60% of investors on Funding Circle an easy exit route for the moment. expected default rates and only 38% 60% invested less than 2% of their financial 50% However, the flow of information on account for fees. However, many wealth on the platforms. This is a good 40% this topic should start to improve platforms do not charge fees to indication that investors are being 30% soon – for example Funding Circle do the investor (64% across the whole cautious, however there where a large 20% publish the volume of loans traded on alternative investment market) so this number of investors investing over 10% 10% their secondary market (at the time of may not apply to most platforms and and over 30% of their financial wealth, 0% writing it is about £5 million a month). can explain part of the response. which is somewhat worrying if they do <2% 2-5% 5-10% 10-30% >30% not have significant capacity for loss. Financial Wealth Source: Nesta (2013)

WHAT % OF YOUR PORTFOLIO COULD BE MADE UP OF YOUR FUNDING CIRCLE INVESTMENTS? Number of respondents 160 Again, this chart demonstrates the

140 optimism Funding Circle investors have about the future. Most investors felt 120 that between 5% and 10% would be a CONCLUSIONS 100 suitable portfolio allocation, with some The majority of the platforms we surveyed were either already marketing to advisers or planned to do so – some had already respondents even stating over 75% 80 received investments from advised clients. They had a good understanding of the size of the opportunity and what advisers’ of their portfolio. Perhaps they know barriers were likely to be. Our guess is that they will be very interested in the results of our adviser survey, and perhaps a 60 something we don’t… little surprised at how little impact they have had on the advice community so far. 40

20

0 <5% 5-10% 10-15% 15-20% 20-30% 30-40% 40-50% 50-75% >75%

Source: Nesta (2013)

72 72 73 “...the most important factors in investors’ decision to lend to a particular company were the financial track record, market potential and the company’s personal expertise in the industry that the company operates"

Q. How important are the following factors in your decision to lend money to a particular company? CONCLUSIONS PERSONAL CUSTOMER EXPERTISE IN THE FINANCIAL TRACK AND MARKET INDUSTRY THAT RECORD POTENTIAL THE COMPANY OPERATES

FAMILY RELATIONSHIP OR REGION IN WHICH PERSONAL FRIENDSHIP WITH THE COMPANY IS KNOWLEDGE OF A MEMBER OF THE BASED THE COMPANY COMPANY

Very important Important Neutral of little importance Unimportant

Source: Nesta (2013)

Lastly, looking at the most important factors in investors’ decision to lend to a particular company were the financial track record, market potential and the company’s personal expertise in the industry that the company operates.

Yorkshire Building Society has also surveyed consumers, discovering that 42% claim to be familiar with the concept of peer-to-peer lending. Of those people, 60% were unaware that peer-to-peer investments are not protected by the FSCS – perhaps a significant finding, although we suspect that awareness of the FSCS could be low in general.

Q. Do you expect to increase the amount you lend through Funding Circle in the coming year? 75% 25% Investors from Funding Circle seem to feel optimistic about their peer-to-peer YES NO lending future, with 75% stating they expect to increase the amount they lend through the platform.

CONCLUSIONS These investor surveys can be read in conjunction with the NESTA / University of Cambridge survey results we included earlier. We think that the University of Cambridge data is the most credible at the moment (rather than surveys by the investment providers). Taken as a whole, the investor survey data presents a mixed picture – but one common theme is low levels of awareness, which could be taken as an indication that there is a lot more growth to come in the sector, and high levels of enthusiasm among the most engaged investors.

74 74 CONCLUSIONS & OUTLOOK SWOT ANALYSIS

is attractive in today’s low-interest READERS OUTLOOK rate environment, the possibility STRENGTHS / WEAKNESSES We hope the report has been insightful. The influx of institutional money is of better risk-adjusted returns, We also hope that we’ve managed to currently a big driver for the industry. additional diversification and lower- lift the lid on a new and fast growing This brings risks with it as well as LOW OVERHEADS COMPARED POSITIVE NEWS FLOW AS ALTERNATIVE TO entry levels to EIS and SEIS benefits. TO INCUMBENT COMPETITORS “THE CITY” AND “BANKERS” asset class and give advisers, SIPP benefits, but overall we think it can only operators, wealth managers and other be net positive - it will give platforms S S INVESTING IN PROVIDES A MEANS TO MAKE A GOVERNMENT SUPPORT AS A MEANS TO retail financial service professionals the scale they need to succeed, help ALTERNATIVE FINANCE SOCIAL IMPACT WITH INVESTMENTS S S ADDRESS SME FUNDING GAP some food for thought. If you’ve to plug the funding gap for SMEs We think the best approach is to build a read the whole thing through from and bring more rigour to the sector. REGULATORY ADVANTAGE OVER LOW COST ACCESS TO EARLY STAGE EQUITY diversified lending portfolio - diversified INCUMBENT INSTITUTIONS S S AND EIS/SEIS BENEFIT cover to cover, you’ll now be able to Inevitably though, there will be winners STRENGTHS across platforms, durations, interest talk knowledgeably about it to your and losers and investors might well LOWER VOLATILITY, HIGHER LOW CORRELATION TO MAINSTREAM rates, business and consumer lending, clients, have meaningful discussions feel like they should stand clear until YIELDING ASSETS S S BOND AND EQUITY MARKETS secured and unsecured loans. This with your peers, and (perhaps most the likely shakeout has occurred. kind of portfolio can be built on a DIY importantly) be able to make an basis, or achieved by investing in one Another big driver for the industry right INEXPERIENCED CHALLENGING FOR SIPPs AND informed decision about what you W W of the handful of new funds that have now is the prospect of big IPOs. We MANAGEMENT TEAMS ISAs TO HOLD want your level of involvement to be. sprung up. The portfolio can be held hope this does not incentivise platforms THE PLATFORMS’ AND THE INVESTORS’ WEAKNESSES LIGHTLY REGULATED IN COMPARISON in either an ISA (directly from 2016 or to sacrifice quality, or their principles, W W ADVISERS AND INTERESTS ARE NOT ALWAYS ALIGNED TO INCUMBENT INSTITUTIONS right now in the case of funds) or a SIPP as they chase higher volumes in the THE ALTERNATIVE wrapper and can also help address hope of getting to the IPO stage. FINANCE INDUSTRY DIFFICULT TO ACHIEVE WHOLE-OF- W W LITTLE TO NO INDEPENDENT non-financial objectives by giving Our surveys tell us that advisers are Nearly everybody is predicting that MARKET UNDERSTANDING FOR IFAS W W ANALYST COVERAGE consumers a higher degree of control wary of alternative finance for the a large platform will go bust in the over where their money is put to work. NON STANDARDISED REPORTING AND VERY SHORT TRACK RECORD THAT DOESN’T near future as well - we suspect that moment, but we suspect that a lot of PERFORMANCE MEASUREMENT MAKE MEANINGFUL ENCOMPASS A FULL BUSINESS CYCLE that is down to unfamiliarity. For many, These non-financial benefits also speak this prediction is based on the law of COMPARISONS BETWEEN PLATFORMS DIFFICULT their perception is that this alternative to equity crowdfunding. Investing averages, rather than any empirical finance is high risk, unproven, in this segment of the alternative evidence, or just the desire of unregulated activity. They’re not aware finance industry is much more risky, commentators to be able to point to of key milestones and developments but the low entry levels are opening their prediction if it does happen and ALT FI MARKET P2P LENDING SPECIFIC CROWFUNDING SPECIFIC such as contingency funds, FCA this asset class up to retail investors claim startling powers of foresight. Well, regulation, meaningful market data, in a meaningful way and many of the shame on us, but we’re no different. the mandatory referral scheme and the current investors enjoy supporting With so many new businesses in a inflow of institutional money. We’re not businesses they like the look of. The crowded space, it’s kind of inevitable OPPORTUNITIES / THREATS sure that some of them are even making prospect of crowdfunding platforms that one of them will make some a distinction between crowdfunding tying up with traditional brokerages critical errors - then the contingency SECURITISATION AND PACKAGING INTO SIPP AND ISA ACCEPTANCE and peer-to-peer (marketplace) lending. and participating in every stage of funds, run-off plans and strength RETAIL INVESTMENT PRODUCTS fundraising activity is very exciting. of the underlying contracts will be TIE UPS WITH BANKS AND So one of the tasks facing the O O Debenture and mini-bonds - securities tested. Useful lessons will be learned, MAINSTREAM FINANCIAL SERVICES INCREASING INSTITUTIONAL INVESTMENT alternative finance industry is to that share some characteristics of for the benefit of everybody else. O O educate advisers and other financial TIE UP WITH ESTABLISHED ONLINE BUSINESSES both lending and equity - are also CAN BUILD INCREASINGLY ACCURATE services professionals about their Overall though, the outlook for the CREDIT MODELS BASED ON BIG DATA SUCH AS AMAZON, EBAY, ALIBABA an exciting development. Some of O O sector. Now this is no joke: advisers sector is positive - despite its rapid OPPORTUNITIES these look very risky, but some look are risk averse when it comes to their growth it still only accounts for a small BANKS ARE NOW MANDATED TO REFER like very good investment options. HUGE TOTAL ADDRESSABLE MARKET client’s money and will take some percentage of investment activity here BORROWERS ON TO PLATFORMS O O convincing - and it's not as if there is a in the UK and levels of penetration shortage of other investment assets and awareness among consumers and HIGHER THAN EXPECTED UNETHICAL TREATMENT OF competing for their attention. But we businesses are still low. There is a lot T T DEFAULT RATES POORLY INFORMED CONSUMERS think that there should be benefits for of growing room! And the sector DOES both sides of the equation if alternative offer a better deal to consumers, more THE CARROT OF A POTENTIAL IPO THREATS CYBER-ATTACK OR A LOSS OF finance and advisers can play well transparency and an alternative to the COULD LEAD TO EXCESSIVE RISK TAKING T T IN A RUSH TO GROW VOLUMES CONSUMER DATA together. Advisers control a huge pool banks and mainstream investments. OPPORTUNISTIC PLATFORMS CAUSE of money that could be put to work It's new, it's exciting and it will UNDISCLOSED LOSSES LEADING T T ISSUES THAT HAVE A REPUTATIONAL via the platforms - and the platforms experience growing pains - but TO A PLATFORM FAILURE T IMPACT FOR THE WHOLE SECTOR can offer a near-cash option that it can't be ignored any more. FAILURE OF A PLATFORM TO ACHIEVE FULL FCA AUTHORISATION

76 77 GLOSSARY OF TERMS BIBLIOGRAPHY

“Moving Mainstream - The European “A Trillion Dollar Market By the “The Financial Advisor’s Guide To P2P Alternative Finance (Alt Fi) Form of financial service that differs from mainstream equity and debt in the sense that the services are provided outside traditional banks. Alternative Finance Benchmarking People, For the People (next line) How Investing” Report” Marketplace Lending Will Remake Dara Albright, James A. Jones and Chris Alternative Investment Market A sub-sector of the London Stock Exchange that lists shares of smaller companies with more Robert Wardrop, Bryan Zhang, Banking As We Know It” Staples (AIM) flexible regulatory requirements Raghavendra Rau and Mia Gray Charles Moldow 13 April 2015 Business Property Relief (BPR) A relief from inheritance tax on qualifying business assets between the rates of 50-100%. February 2015 2014 “The Rise Of Future Finance-The UK “Banking for the 21st Century: driving “The Future Of Finance Part 3 The Crowdfunding (CGT) The practice of funding a project or venture by a large group of individuals. Typically does not Alternative Finance Benchmarking competition and choice” Socialization of Finance” require a large amount of capital to be invested. Report” HM Treasury Heath P.Terry, Debra Schwartz and Tina Liam Collins, Richard Swart and Bryan Enterprise Investment Schemes A series of UK tax reliefs originating in 1994 with the aim to encourage investments in small March 2015 Sun Zhang (EIS) unquoted companies in the UK. 13 March 2015 December 2013 Financial conduct Authority The financial regulatory body in the UK that operates independently of the government. “Banking On Each Other - Peer-To- (FCA) Peer Lending To Business: Evidence “P2P Lending: Opportunity & how to “Understanding Alternative Finance- From Funding Circle” invest" The UK Alternative Finance Industry Her Majesty's Revenue and A non-ministerial department of the UK Government responsible for the collection of taxes, the Yannis Pierrakis and Liam Collins Cormac Leech, Karen Lucey, and Minh Tran Report” Customs (HMRC) payment of some forms of state support, and the administration of other regulatory regimes including the national minimum wage. April 2013 11 March 2014 Peter Barch, Liam Collins and Bryan Zhang High Net Worth Investors (HNW) Investors with over £200k in investible assets or an annual income in excess of £100k per annum. November 2014 “The Voice of the People: Insights “The Essential 8 Best Practices to from the latest Peer-to-Peer Lending Marketplace Lending Investing” “Increasing ‘The Vital 6 Percent’: ICAP Securities and Derivatives An independent stock exchange in the UK that lists smaller and growing companies. Research” Jeremy Todd Designing Effective Public Policy to Exchange (ISDX) Bryan Zhang 8 April 2015 Support High Growth Firms” Individual Savings Account (ISA) A retail investment scheme which enables individuals to hold cash, shares and unit trusts with tax 17 November 2014 Ross Brown, Colin Mason and Suzanne free growth. "Herding Behavior In Online P2P Mawson “The FCA’s regulatory approach to Lending: An Empirical 1 Investigation” Mini-Bond A debt instrument issued by smaller companies that pays the lender interest and principal upon January 2014 crowdfunding (and similar activities)” Eunkyoung Lee, Byungtae Lee and maturity. The Financial Conduct Authority Myungsin Chae “Working The Crowd- A Short Guide to Open-Ended Investment A type of open-ended collective investment scheme with a reasonable expectation of liquidity. October 2013 2011 Crowdfunding And How It Can Work Companies (OEICs) For You" “Crowding In - How the UK’s “The business finance guide-A Peer-to-Peer Finance Represents a large majority of the alternative financial services market in the UK including peer-to- by Peter Baech and Liam Collins Association peer lending to consumers as well as invoice financing Businesses, Charities, Government, journey from start-up to growth” May 2013 and Financial System Can Make The Marc Mullen and David Petrie Peer-to-Peer Lending The practice lending of money to individuals or businesses without the use of a traditional financial Most Of Crowdfunding” June 2014 "Be The Bank – How to Earn High intermediary. Includes peer-to-consumer lending, peer-to-business lending and invoice financing. Peter Baeck, Liam Collins, and Stian Returns Securely by Lending to SMEs” Net asset value (NAV) The value of an asset after deduction of any liabilities. Westlake Richard Admiral December 2012 June 2015 Professional Indemnity PI covers costs and expenses incurred in your legal defence, as well as any costs that may be Insurance (PI) awarded, if you are alleged to have provided inadequate advice, services or designs that cause your client to lose money. Seed Enterprise Investment A series of UK tax reliefs launched in 2012 to encourage investors to finance high-risk startups. Scheme (SEIS) Different from EIS due to the amount of tax relief received from investing.

Self-Invested Personal Pension / UK government-approved personal pension schemes that enables individuals to make independent Small Self-Administered Scheme investment decisions. (SIPP/SSAS) Small and Medium-Sized A company with fewer than 500 employees and an annual turnover of less than £100 million Enterprise (SME)

United Kingdom Crowdfunding An association that promotes crowdfunding for UK businesses, projects and ventures Association (UKCFA)

78 79 PLATFORM REGISTER PEER-TO-PEER LENDERS The data is as of November 2015

INVESTMENT PLATFORM DETAILS LENDING MARKETS OFFERED SECURITIES DETAILS INVESTMENT OPTIONS ALTFI DATA VOLUMES BASICS

"PRODUCTS" MARKET PROVISION SECURED UNSECURED INSTITUTIONAL CHARGES MINIMUM "AUTOBID" "REINVEST" SELF CUMULATIVE PLATFORM INCEPTION DATE P2B P2C SPECIALISM PRODUCT MIN GROSS SHARE (<3 YEAR TO DATE FUND LENDING LENDING LENDERS TO LENDER INVESTMENT FUNCTION FUNCTION INVEST TOTAL NAME INVEST INTEREST MONTHS)

ASSET 2014 £1,000 £1,000 7.00% 0.31% £8,475,000 £6,595,000 √ x x √ x √ BACKED x √ x √

2013 √ √ √ √ x GENERALIST x £0.01 £20 9.00% √ √ √ 0.66% £83,053,044 £27,404,736

2013 √ √ x √ x REGIONAL x £25,000 £25.000 7.00% x x √ 1.60% £74,902,550 £34,065,400

A+ £20 8.20%

A+ £20 10.30% 2009 x √ x √ √ √ SME √ £20 B £20 10.36% √ x √ 20.52% £908,626,520 £431,978,040 C £20 11.40%

C- £20 12.90%

2013 x √ x √ x √ SME √ £25 £25 10.58% √ x √ 0.71% £27,066,500 £17,613,500

ASSET 2013 £25 £25 12.70% 0.77% £16,224,433 £12,947,530 √ x x √ x BACKED x x x √

2014 x √ √ √ x √ PROPERTY x £100 £100 4.20% x x x 0.82% £13,946,030 £12,181,545

2014 x √ x √ √ √ GENERALIST x 0.23% £7,205,991 £6,294,140

3 years £10 5.10% 2014 x √ √ x √ GENERALIST x £10 √ √ √ 0.57% £16,290,975 £11,602,076 5 years £10 6.20%

ASSET 2011 £50,000 £50,000 14.53% 12.07% £558,568,550 £245,144,672 √ x x √ x √ BACKED √ √ x √

2014 √ x x √ x SME √ £100 £10 10.00% x x √ 0.10% £6,899,300 £3,494,300

2012 √ x x √ x √ GENERALIST √ £50,000 £50,000 15.00% x x √ 1.34% £105,550,850 £22,746,735

Tranche C £5,000 10.44% COMMERCIAL 2014 £5,000 Tranche B £5,000 8.30% £7,620,500* £6,513,500* √ √ √ √ x √ PROPERTY √ x x √ Tranche A £5,000 6.98%

The platforms included on the register are those that are included within the Liberum AltFi indices. *Data provided by Proplend These platforms were not chosen for any particular commercial reason.

80 80 81 PLATFORM REGISTER PEER-TO-PEER LENDERS The data is as of November 2015

INVESTMENT PLATFORM DETAILS LENDING MARKETS OFFERED SECURITIES DETAILS INVESTMENT OPTIONS ALTFI DATA VOLUMES BASICS

"PRODUCTS" MARKET PROVISION SECURED UNSECURED INSTITUTIONAL CHANGES MINIMUM "AUTOBID" "REINVEST" SELF CUMULATIVE PLATFORM INCEPTION DATE P2B P2C SPECIALISM PRODUCT MIN GROSS SHARE (<3 YEAR TO DATE FUND LENDING LENDING LENDERS TO LENDER INVESTMENT FUNCTION FUNCTION INVEST TOTAL NAME INVEST INTEREST MONTHS) 1 month £10 3.10%

1 year £10 4.40% 2010 √ √ √ √ √ √ GENERALIST x £10 x x x 19.27% £874,423,150 £430,512,846 3 years £10 5.70%

5 years £10 6.70%

2013 √ x x √ x PROPERTY √ £500 £500 8.00% √ √ 0.00% £4,911,000 £1,686,000

2013 √ x √ √ x √ PROPERTY x £100 £1,000 12.00% x x √ 2.69% £67,442,807 £52,507,500

2011 √ x x √ x √ SME √ £1,000 £1,000 10.57% x x √ 1.68% £135,179,000 £46,796,000

18 months £10 4.00% *Crowdcube mini-bonds are classified under peer-to-business lending on the Liberum AltFi Indices ** VentureFounders does not currently supply3 years data for£10 tracking by4.75% AltFi Data 2013 √ x √ √ x SME x £10 √ x x 2.93% £275,823,144 £132,259,879 5 years £10 5.50%

30 days £10 3.50%

3 years £10 3.80% 2005 x √ √ x √ √ GENERALIST x £10 x √ x 22.63% £ 1,153,213,753 £909,697,615 5 years £10 5.00%

The platforms included on the register are those that are included within the Liberum AltFi indices. These platforms were not chosen for any particular commercial reason.

82 82 83 PLATFORM REGISTER CROWDFUNDING PLATFORMS The data is as of November 2015

PLATFORM DETAILS PRODUCTS OFFERED DETAILS INVESTMENT BASICS INVESTMENT OPTIONS ALTFI DATA VOLUMES

PRE EMPTION MARKET MINI- NOMINEE VALUATION CHARGES MINIMUM CUMULATIVE PLATFORM INCEPTION DATE EQUITY DEBENTURE FUND SPECIALISM EIS / SEIS AND/OR TAG SHARE (LAST YEAR TO DATE BONDS ACCOUNT ( COMPANY/ INVESTOR LED) TO LENDER INVESTMENT TOTAL ALONG RIGHTS 3 MONTHS)

2011 x x √ x x INDEPENDENT VALUATION RENEWABLE ENERGY x N/A x £5 0.09% £11,853,503 £3,355,862

2011 √ √ x x √ COMPANY LED SME √ x x £10 0.00% £3,675,359 £1,571,999

PRE-EMPTION 0.18%* £10,368,500* £5,840,000* 2012 COMPANY LED SME £10 √ √ x √ √ √ ON A SHARES x 84.37% £102,388,913 £60,364,211

2013 √ x x x √ INVESTOR LED SME √ √ x £1,000 32.97% £38,878,632 £22,403,247

2012 x √ x x x COMPANY LED GENERALIST x N/A x £5,000 0.14% £5,581,000 £2,315,000

2014 √ x x x √ INVESTOR LED SME √ √ √ £1,000 ** ** **

*Crowdcube mini-bonds are classified under peer-to-business lending on the Liberum AltFi Indices ** VentureFounders does not currently supply data for tracking by AltFi Data

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