Conversely to my recent post that equity crowdfunding doesn’t exist, debt crowdfunding I believe is almost a foregone conclusion. This is also ironic since only about 4% of the 50 sites I looked at were debt crowdfunding sites (as opposed to 18% for equity crowdfunding). Prosper and Lending Club are two of the more prominent debt crowdfunding sites (at least in the US). Also ironic is that equity crowdfunding gets much more positive press than debt. They say “Invest in the next Facebook, Google or Twitter” like you are simply a click away from making millions. This is highly unrealistic. However, getting a 6% to 8% return by “peer lending” money is very realistic, albeit quite a bit less exciting. Here are my arguments as to why debt crowdfunding has promise. I’ll use the same structure I used in my analysis of equity crowdfunding.
They are more inclusive.
The debt sites I examined are also currently limited to Accredited Investors. This is to be expected since it is the law (in the US at least). However, they are positioned well to adapt to Title III of the JOBS Act (crowdfunding) when the SEC does deliver approved rules. It seems that they always intended to adapt. The whole process from signing up to investing to tracking all could remain the same. The only adjustment would be no need to qualify oneself as an accredited investor when signing up. I can foresee a boom in participation once the crowds are allowed to invest and made aware. In fact, I will go on the record as saying it is the supply side that will limit growth. The crowdfunding sites will struggle to keep a satisfying flow of loans available to the crowds. If anything, this will cripple a debt site and cause an exodus of the crowd.
They are inexpensive to investors.
Investment minimums for debt crowdfunding are as low as $25.00. And service fees are usually less than 1% of the return. These are numbers that the crowd can handle. I believe that the costs to get a loan are still a bit high but as debt crowdfunding grows and competition for loans increases we will most likely see origination fees decline. Now the $25.00 minimum and the 2000 investor limit currently restricts the amount of a loan to a maximum of $50,000. But when Title III hits the limit will be constrained by the $1M annual limit vs. the number of investors. For peer lending to your average citizen this limit isn’t much of a limit. But it also provides plenty of room for loans to small businesses. So I see the opportunity for debt crowdfunding to expand or grow to new types of loans.
Last week I examined 1300 peer-lending loans and here were some findings. There were two major reasons for the loans. 58% of the loans were loan refinancing or debt consolidation and 28% were for credit card payoff. The next most frequent reason was home improvement at a distant 4.36%. Small business loans were 1% and home purchase was .5%. So right now debt crowdfunding is primarily an alternative to high interest credit cards. Over time I would expect to see this change as debt crowdfunding becomes more main-stream. I would expect, in particular, to see business loans, home improvement, and major purchases grow as a larger percentage. However, I believe credit payoff/consolidation to dominate for the next 3-5 years. Other interesting numbers include 40% of the loans were from people with over a 700 FICO credit score. 65% of the loans had a 36 month term and 35% had a 60 month term. 3% of the loans had over a 20% interest rate. 61% had a rate between 10% and 20% and 35% had a rate below 10%. The lowest interest rate was 6%. This may not be the same as holding shares of the next Facebook but it is pretty compelling when compared to savings and CD interest rates.
They are transparent (enough).
The sites provide basic information on the loan such as the reason, the term, the rate, the amount, credit score, and some site risk score. There are often additional details such as the location (State) of the loan, length of employment and verified income. This should be enough information for due diligence on a $25.00 investment. Most of the risk management comes from the risk balance of a portfolio of loan notes. A non-accredited crowdinvestor who has $2000.00 to invest can assemble a portfolio of 80 notes that together comprise an acceptable level of risk. Lending Club, for one, provides information on a selected portfolio including anticipated default rate before you execute on buying the set of notes.
They are direct.
With a few clicks you directly invest in the notes. You don’t have to request more materials or apply for the opportunity to invest. You don’t invest in a security that assembles a set of notes by multiple tranches (sound familiar). You invest in an individual loan note. Within minutes you can assemble a portfolio of 100s of notes. Now it can take a week or two for those notes to close and a subset of them won’t close so it can take several tries and a several weeks to invest all your money. Then about 30 days after your first note closes you will start to see returns accrue. And this, of course, depends on the number of loans available for investment. If you want to invest $50,000, $25 at a time, in notes that have a 36 month term, a credit score over 750 and are originated in Texas then it can take you a long time to get that money invested. But if you are less restrictive and put $25 across a variety of notes then it will go much more quickly. With debt crowdfunding where risk is spread across many loans, investment risk management shifts from the individual investment to the portfolio.
All of these factors combine to make debt crowdfunding more appropriate for the masses than equity crowdfunding. Although equity might get more crowd-friendly, I believe the near-term and mid-term promise for crowdfunding securities lies with debt.
As always, I’m interested in questions and opposing or supporting positions. If anyone knows of great debt crowdfunding sites then please let me know and I’ll look at them.
Soon I’ll move on to reward based crowdfunding.
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