July 22, 2020 Last updated July 22nd, 2020 1,074 Reads share

The Comparison Between Crowdfunding and Peer to Peer Lending

Image Credit: DepositPhotos

For the last few years, borrowers have had significant difficulty in securing finance from mainstream banks. This is especially true for small scale businesses who are suffering much due to the financial dip of recent times. Most of these borrowers have managed to get their projects funded using alternative finance options like crowdfunding and peer to peer lending.

Both these finance solutions are based online and offer a reliable finance solution apart from the high street investors’ strict criteria. Both have their own unique benefits. Even though both these solutions may appear similar, but it is essential to understand the fundamental difference before you start investing.

What is Peer to Peer Lending?

For a long time, people have been lending each other money on their own terms bypassing the banks altogether. Peer to peer lending uses this as a fundamental principle with some tweaks to protect people on both sides of the arrangement. Most p2p lends exist only online and take secure loans against different assets like property. A peer to peer platform matches borrowers with potential lenders online. Generally, the rewards and risks with peer to peer are modest. Most p2p platforms specialize in lending to different types of borrowers such as consumers, businesses, or property owners. Investors can diversify their investment across several borrower types.

 Peer-to-peer platforms like Kuflink bring borrowers and lenders together. P2p offers lenders the choice to fund loans in return for interest.

What is Crowdfunding?

This finance solution is used to borrow money for different projects. It has become the preferred funding method for most innovative start-up businesses. From vegan lunches to craft beer brands, lenders can pick the projects they believe in, in return for equity in that business.

Businesses that raise funds through this type of funding mostly offer additional perks to develop a long-term relationship with their lenders. The perks vary according to the company; for instance, a drinks brand may provide free bottles of their products to their lenders.

What Are the Similarities?

To many, both these finance terms may appear similar, as both have investors contributing to raising funds, and both have become a popular alternative for funding. Both these funding solutions remove the middleman ‘bank’, which are known for inflexible terms and slow procedures of agreements.

Both these funding platforms have opened up the investment opportunities to a broader crowd since their structure is more accessible, less technical compared to the traditional bonds or stocks and shares. These are also quite popular among seasoned investors who wish to diversify their portfolios, primarily because of the effect that Brexit has on property and stock markets. Remember, as with all the investments, in both cases, and your money is at risk.

What Are the Differences?

  • The significant difference between both finance solution is that peer to peer is loan-based and crowdfunding is equity-based. Also, peer to peer loans often have a fixed rate, but in some cases, a target interest rate is given. Since the monetary value of equity in a company depends on its performance, the returns are more variable with crowdfunds.
  • Also in p2p lending, the terms are mostly fixed dependent on borrowers meeting their repayment date. Contrarily, in crowdfunding, there are no fixed terms, and it is up to investors to decide how long they can hold on to their equity.
  • Another big difference is the relation between lenders and borrowers. For peer to peer, there is no direct relationship between a lender and a borrower. Although some details like credit history might be provided to the investors, they won’t know the identity of the borrower. The platform conducts background checks, and investors use this information to make the decision of whether they want to invest or not.

On the other hand, with crowdfunding, the borrowers directly pitch to the potential investor, who then conducts their due diligence. This relation is closer since it is an ongoing partnership where both sides benefit from the successful performance of the borrower.

  • Finally, from a borrower’s point of view, with crowdfunding, you are giving away equity, while with peer to peer, you pay interest on the loan. The interest that you pay on peer to peer loan is often split between the platform and the investors. For example, if you are paying a 7% interest rate per year, then the investors might earn 4% per year, and the platform will get the remaining 3%. Despite the outcome of the project, you will be liable to repay the loan along with interest or you risk having your security repossessed.

The debate of which finance solution is better can be tough to navigate. However, once you understand the requirements and benefits of each solution, you can make the right decision for your investment.

DepositPhotos – crowdfunding

Sana Tahir

Sana Tahir

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