Peer to peer lending, crowdfunding and microfinance – what’s the difference and why does it matter?

people working together

Peer to peer lending is a relatively new form of alternative finance that has the potential to significantly improve the flow of business funding to British small businesses.  P2P Lending, however, is just one of a whole host of new finance options that have suddenly burst onto the scene.  If you’re confused about what crowdfunding is, wondering about microfinance or simply keen to investigate what is the best investment or which funding options exist for a small business loan read on for our quick and simple guide to alternative finance.

 

For several years now we’ve been hearing about how and why the mainstream banks are struggling to meet the business investment needs of UK small businesses.  By now, it’s hard not to know that banks are being forced to re-build their capital bases and that, in everyday terms, this means that there’s less available to lend out to small businesses, almost regardless of how creditworthy they may be or how much the banks actually want to lend.

If there’s a lesson to be gained from the recent pain of the credit crunch, recession and ongoing bank bashing it is the realisation that the private sector needs to become more involved in funding for business. Banks can’t be asked to shore up their cash reserves with one hand and lend out more business loans with the other.  They need a helping hand, and that is where alternative finance can step in.

Peer to peer lending connects lenders and borrowers whilst maximising the rewards for both.

Borrowing from the voice of the crowd on Wikipedia, Peer to peer lending or P2P finance as it is sometimes known is a “financial transaction (primarily lending and borrowing, though other more complicated transactions can be facilitated) which occurs directly between individuals or “peers” without the intermediation of a traditional financial institution.”

In layman’s terms, that means that a peer to peer lender – like FundingKnight – creates a marketplace to connect people who want a better return on their investment with borrowers who need additional funds.

Peer to peer lenders can then be split further into those making personal loans to individuals – like Zopa or Ratesetter – and those who help lenders invest directly in businesses – like FundingKnight and Funding Circle.

Peer to peer lending aims to maximise the benefits for both lenders and borrowers.  Lenders typically earn more from their savings and investment than they would in a high street deposit account and borrowers can take advantage of terms that are often more competitive and flexible than the banks are able to offer.

So what about crowdfunding or micro-finance, different sides of the same coin, correct?  Well, no, actually, there are significant differences between these three growing forms of alternative finance.

Crowdfunding involves parting with a stake in your business and predicting which businesses will succeed.

Crowdfunding, sometimes called crowd financing or equity crowdfunding is actually radically different from peer to peer lending.

Borrowing from the “How it Works” section of leading UK crowdfunder, Crowdcube:

Crowdfunding is “a newfangled way to raise investment and business finance by tapping into a ‘crowd’ of like minded trendsetters willing to invest smaller amounts of cash in exchange for rewards and a stake in their business.”

So, crowdfunding not only means that businesses looking for a business loan have to part with some equity instead, it means that any potential investor needs to think carefully about the future prospects of the business they are becoming a part of.

Rather than lending to the type of established, proven British small businesses that FundingKnight lends to, crowdfunding often appeals to start-ups.  That’s great if you want to spot the next best thing and jump aboard the trend.  Less good if you simply want a better return on your investment for the minimum of extra hassle.

Microfinance helps those who are struggling to access financial services

So, finally, we come to microfinance.  Returning to Wikipedia, microfinance is usually understood to entail the provision of financial services to micro-entrepreneurs and small businesses, which lack access to banking and related services due to the high transaction costs associated with serving these clients.”

It’s also sometimes used to “describe the supply of financial services to low-income employees”.  Microfinance has lots to recommend it.  It can promote economic development, aid employment and growth – particularly in developing countries – and generally help the world’s poorest people climb out of poverty.

Those are noble aims and might particularly appeal to people looking to ‘give something back’ with their money rather than necessarily maximise investment returns.

So, peer to peer lending and the wider world of alternative finance.  We hope we’ve helped to clear some minds with this post and if you’re left with any nagging questions, ask away, we’ll always do our best to help.

Coming next: a post from FundingKnight’s CEO, Graeme Marshall, on why FundingKnight is firmly committed to the peer to peer lending space rather than crowdfunding.  To avoid missing out and to receive regular updates please do subscribe to the FundingKnight blog or connect with us via LinkedIn or @FundingKnight on Twitter.

Photo used under creative commons licence

One thought on “Peer to peer lending, crowdfunding and microfinance – what’s the difference and why does it matter?

  1. Pingback: P2P Lending and why FundingKnight aims to stand out from the crowd | FundingKnight: The Blog

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s