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Crowdfunding: debt vs equity - which is right for me?

For those new to crowdfunding, it can come across as a confusing! However, all crowdfunding really does is provide an optimum solution for people, businesses and charities looking to raise capital for a project, cause or an individual project as opposed to going to the bank for funding.

Crowdfunding brings together various individuals or organisations who are willing to micro finance a project they want to support or partially invest in a sector they had always had an interest in.

Below is a summary of why this form of alternative finance is trending, how to become a contributor to a crowdfunding platform but, above all, how to make the best of it. Bear in mind, crowdfunding has a variety of types. Which one is right for your circumstances? How well do you know the differences between reward, debt and equity crowdfunding?

Why are more people using crowdfunding and how does it work?

Crowdfunding is transforming the way people behave with their money and potentially challenging sectors of traditional finance, disrupting the various models including fund management and venture capital firms as well as the role of the angel investor.

Banks and other senior lenders are simply not prepared to finance as much as they used to, yet now multiple investors can contribute to one project. Once only available to HNWI and institutional investors whilst potentially gaining those higher returns. If you think about it on a broader scale, this form of alternative finance is beneficial for the current economy on a wider scale.

When you are looking where to invest money, there are many crowdfunding platforms to choose from where an investor is offered an overview of projects.

Different types of crowdfunding

There are many different types of crowdfunding. Let’s first look at the simplest model, referred to as Reward Crowdfunding. Kickstarter, IndieGoGo and Crowdfunder are perfect examples where investors invest in a cause, project or venture that they believe in, in return for products, tickets, free gifts and acknowledgements.

However, the main types of crowdfunding categories are Equity Crowdfunding and Debt (P2P) Crowdfunding. Below is the definition of both as well as their pros and cons. To understand their differences best, lets look at them from a property crowdfunding angle.

For individuals who always dreamed of venturing into property investment, Property Crowdfunding has made this easy. With the crowdfunding model in mind, it is a great way to broaden your property portfolio, using a relatively small amount of money and with limited experience in the UK property market.

Like any form of investment, it is always important to consider the key risks before you commit to investing your hard-earned cash. When it comes to Property Crowdfunding, there are several different investment options available, but they mainly fall within either Equity Crowdfunding or Peer to Peer (P2P) Crowdfunding.

When considering the best property investment options for you within Property Crowdfunding, being able to differentiate between Equity Crowdfunding and Peer to Peer Lending is more of a must as every property investor has different end goals and needs to be confident as to which options would benefit their situation the most. Let’s take a look at both of these Crowdfunding options and assess the advantages and disadvantages of each.

Peer to peer (P2P) crowdfunding

Also known as Debt Crowdfunding, or Debt Lending, P2P involves a large pool of investors lending money to a company or project in exchange for a debt instrument that pays fixed term returns and interest. Interest will either be rolled up and paid at the end of the loan term or paid quarterly depending on the structure. These types of investment opportunities are generally available prior to development works taking place.

The advantages of P2P

Debt Crowdfunding is a very attractive option for investors looking to get a fixed return and it is a relatively low risk proposition compared to Equity Crowdfunding as it loans for a fixed term and rate. Further to this, your capital will most usually be secured by a charge on the project asset, whether it may be land or property. Should there be an issue in repaying your capital, the P2P lending platform will be able to force a sale of the asset to recoup any outstanding capital or interest.

Another significant advantage of investing through such debt investment is that you can invest using your ISA allowance via an IFISA (Innovative Finance ISA) and take advantage of tax breaks.

The disadvantages of P2P

P2P Crowdfunding is generally lower risk which corresponds with lower returns compared to equity investments. Returns for Debt Crowdfunding fall in a range between 5% and 9% per annum on average. You will also have little say over how your loan is spent by the borrower you are lending to. Although you receive a fixed return, you do not benefit from any of the additional upside should the project outperform expectations.

It should be noted that even though debt investments have been perceived to be lower risk, the portals will still be required to do the same level of due diligence as they would for equity type investments. They will also have to assess the company’s ability to meet the repayment schedule to the investors.

Equity crowdfunding

Equity Crowdfunding is where multiple people commit to investing in an unlisted company or project in exchange for equity in that project or company. In other words, money is exchanged for shares or a small stake in a business or project, meaning investors get their returns through profits, or dividends.

Once reserved for the likes of high net worth individuals, venture capitalists and angel investors, this type of crowdfunding is now opening equity investment opportunities to everyone, particularly when it comes to property investment.

The advantages of equity crowdfunding

Equity crowdfunding is generally considered a high yield investment meaning this type of online investment offers significantly higher levels of returns. In fact, the average annual returns for Equity Crowdfunding can typically range from 15% to 25% per annum compared to returns in the 0.5% and 3% range that an individual can expect who leaves their money sitting in a bank.

The disadvantages of equity crowdfunding

Equity funding can present a higher level of risk, as your returns are guaranteed significantly less than debt funding. It is also worth bearing in mind that, if you invest in a start-up or project, there’s always the possibility that the company or project could fail. If you are wondering how to make money through property, property development projects usually fall into the equity space and help to compliment a well-diversified property portfolio, yet property development has a lot of potential pitfalls which can result in significant loss of capital.

The bottom line

Any type of investment comes with elements of risk, as well as rewards. The key to deciding how to invest in property through crowdfunding is balancing the risks and the rewards. So, for example, if you are willing to take a slightly higher risk, you can reap significantly higher returns through Equity Crowdfunding.

If your risk appetite is more conservative, you can opt for the Debt Crowdfunding option that offers the fixed return and interest. 
If you are eager to find out where to invest in property in the UK, Shojin Property Partners can assist you with everything, from education on the property market, to property investments and an easy registration and online investment process. We are proud to be one of the UK’s best property crowdfunding companies, offering a host of investment opportunities whether you are drawn to debt investments or equity investments.

Shojin offer investors the opportunity to invest across the entire property sector from buy to let investments all the way through to property development. Click the link to find out more on our products page.

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