The Financial Conduct Authority (FCA) has accused peer-to-peer and crowdfunding sites of misleading investors about the risks involved.
The financial watchdog claims that some providers of crowdfunding, mini-bonds and peer-to-peer lending are attracting investors by providing "a misleading or unrealistically optimistic impression of the investment".
Boom times for alternative ways of saving
Peer-to-peer lending is where you lend your money to an individual or business, and benefit from a far higher rate of return than with a normal savings account. Meanwhile crowdfunding is where you invest in a firm, and get an equity stake, or else lend them money by buying mini-bonds. Both peer-to-peer and crowdfunding have exploded over the past year.
In 2013, peer-to-peer lending in the UK reached £480 million, but almost tripled to £1.3 billion last year, according to a report by Nest and the University of Cambridge. In addition, investment-based crowdfunding platforms offering equity investments and bonds enjoyed huge growth too, raising £84 million last year, versus £28 million in 2013 and a mere £3.9 million in 2012.
This growth has been fuelled largely by British savers fed up with awful interest rates on offer at traditional banks and building societies. However, some savers pumping money into these ventures are unaware of the true risks involved, because a few providers are not being entirely honesty about the true risks involved.
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The risks to your money
The regulator found that some peer-to-peer and crowdfunding platforms promised double-digit returns to investors or lenders without making clear that these investments were far, far riskier than traditional deposit accounts.
The FCA found examples where platforms:
Misled investors by claiming that lending or investing was almost as safe as cash on deposit when, in fact, these schemes carry a vastly greater risk of loss.
Failed to explain adequately that peer-to-peer loans are not covered by the Financial Services Compensation Scheme. The FSCS safety-net covers 100% of the first £85,000 of cash savings per individual per institution.
Cherry-picked the information supplied to customers (such as deleting negative comments) to produce a misleadingly positive.
Provided a lack of balance when highlighting prospective returns to lenders and investors.
What's more, the FCA warns that the true risk of loss from investing in small companies is far greater than most small investors imagine. Typically, four out of five (80%) start-up businesses fail in their first two years.
In addition, the risk of failure extends to the platforms themselves. Should a crowd-funding platform go bust (as has already happened several times), investors can be left with little or nothing to show for their investments.
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When things go wrong
Already, UK investors have seen crowdfunded investments or bonds turn sour as their issuers get into trouble.
For instance, the UK arm of Australian company CBD Energy launched its Secured Energy Bonds in October 2013. These offered a fixed yearly return of 6.5% on a minimum investment of £2,000. The firm sold £7.5 million of these mini-bonds to almost 1,000 investors, with the funds raised to be used for solar installations. However, CBD went into administration last month, with the prospect of investors losing most, if not all, of their money.
Take Bubble & Balm, which was the very first company to raise money via crowd-funding site Crowdcube in 2011. The company sold 15% of its equity to 82 investors for £75,000, valuing the fair-trade soap-maker at £500,000. The firm ceased trading in July 2013, losing investors all of their money.
To quote the FCA on crowdfunded investing: "It is very likely you will lose all your money."
Things to bear in mind
Before you think about putting your money into either peer-to-peer loans or crowdfunding, there are a number of key things to consider.
Not only are such investments inherently risky, but they are also highly illiquid. They can be very difficult to sell on second-hand. You may be locked in for several years, so don't put any money into these products that you may need back in a hurry.
Most small businesses fail before they ever make any real or sustainable profits. So it's a gamble. You should never invest more than you can afford to lose into a single company or sector. You must spread your risk by diversifying, so you don't end up with too few eggs in your investment basket. Also, make some allowance for losses and bad debts.
If you're going to put some money into peer-to-peer loans or crowdfunding, make sure you do your research. There are over 90 sites operating in the UK, so choose your platform carefully. Ideally, pick a member of the Peer-to-Peer Finance Association (P2PFA).
What do you think? Are these sites guilty of downplaying the risks involved? Let us know your thoughts in the comments box below.
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