Study of UK Peer-to-Peer Lending Hints at Potential Crowdfunding Participants

Shortly after the first anniversary of the Jumpstart Our Business Startups Act (JOBS Act — see the March 28, 2012 issue of the Digest) Mary Jo White was sworn in as the 31st Chair of the Securities Exchange Commission (SEC). In the crowdfunding and tech communities, Chairperson White's appointment sparked significant discussion about the future of SEC regulation of equity-based crowdfunding and when the regulations would be released. According to a recent Bloomberg article, Chairperson White intends to prioritize establishing rules mandated by the JOBS Act by pushing for changes that will allow hedge funds to advertise to the general consumers. Although there is no clear timeline for the release of these equity-based crowdfunding rules — experts believe it could be as early as the end of 2013 or well into 2014 — some important questions remain:

• Who will invest via equity-based crowdfunding platforms?
• What incentives are there for startups to crowdfund?
• How will equity-based crowdfunding work with other traditional forms of financing (e.g., banks, angel investors, venture capital)?
• Will investors be subject to fraud?

Until the SEC releases its regulations, many of these questions cannot be answered definitively. However, a report from Nesta, a nonprofit innovation research foundation in the United Kingdom (UK), might provide some new insight into the pool of investors (highly educated investors willing to make small investments in several companies) and the businesses (mostly those that could not receive traditional bank financing) that will be drawn to equity-based crowdfunding. In Banking on Each Other, Nesta researchers examine the UK's online peer-to-peer (P2P) lending market, which has been active and thriving since 2005.

Via peer-to-peer lending portals, investors provide small loans to individuals or entrepreneurs with the expectation of a return on investment in the form of interest. Currently, P2P lending portals exist in the U.S. (e.g., LendingClub or Prosper), but are strictly regulated under existing SEC regulations and open to accreted investors. In the UK, these portals allow the crowd (unaccredited investors) to lend money to companies (instead of individuals) seeking debt finance. Although, equity-based crowdfunding and P2P lending are different, these platforms in many ways are serving a similar role to the purposed equity-based crowdfunding portals.

Nesta focused its research on one of the UK's most successful and largest P2P lending portals — Funding Circle. Through the report, Nesta provides insights on participant and investment characteristics. It also examines the motivation behind the decisions made by both lenders and borrowers. They collected data from 630 investors who lent £4.1 million (approximately $6.4 million US) via 34,700 loans to 89 companies.

Via survey data, Nesta was able to establish a profile of a P2P investors — a typical lender is male (83 percent of respondents), highly educated (about 37 percent hold an advanced degree) and relatively wealthy, with a science, business or finance degree. Surprisingly, most of P2P lenders have no entrepreneurial experience. They on average have made 67 investments to companies with an average investment of £157 per company (approximately $244 US) for a total average investment portfolio of £7,983 (approximately $12,415 US). Their investments are driven primarily by interest offered, risk rating and the financial track record.

The report also provides details related to the businesses that borrow via Funding Circle. According to the report, the average size of the loan raised by the surveyed companies is £35,000 (approximately $54,432 US) via 418 investors (approximately $130 per investors). These loans were primarily for business expansion. Most of these companies (60 percent) attempted to secure a bank loan before approaching Funding Circle. Thirty–two percent of surveyed companies responded that without using P2P lending, it is likely or very likely that they wouldn't have received external finance. The most significant benefit to using a P2P lending site was speed in securing a loan — on average 12 days for Funding Circle as compared to six to 12 weeks via a bank.

The more inclusive P2P lending market in the UK might provide insight into the characteristics of investors that might drawn to equity-based crowdfunding domestically once the SEC regulation is enacted. However, as Nesta warns, there has not been enough research into the characteristics of equity-based crowdfunding investors to draw many conclusions — preliminary data indicates crowdfunding investors may be more diverse than P2P lenders due to more diverse motivation for financing projects. It may be more appropriate to draw conclusions about the types of companies that might be interested in equity-based crowdfunding based upon the Nesta research. It also indicates how P2P lending might evolve in the U.S. once SEC regulations change through the creation of P2P platforms that allow unaccredited investors to participate.