Lending to businesses is complex. Investors need skill, knowledge and some luck

Unsecured business loans are the most difficult P2P loans to analyse. Why? To do it properly, you need to have knowledge of basic accounting and finance concepts, and also have the time to perform your  own assessment of the risks of each loan. There’s a lot that can go wrong, and investors need a lot of information to assess the risk.

Other types of P2P loans tend to require far less analysis as they tend to either be secured on real estate, be part of a large diversified portfolio, or come with buyback guarantees. 

Some P2P sites seem to treat their investors as ‘dumb money’

There’s a popular term among investment professionals about anyone who invests in assets they don’t have sufficient experience or expertise to understand the risk or price it properly. These people are called ‘dumb money’ and the professionals will always try to take advantage by selling assets to them at too high a price, or too low a return. 

Some European P2P investment sites that offer unsecured business loans appear to be treating their investors in the same way. Why do we say this? Because in many cases the sites provide almost no information at all that any experienced investor would demand to know before investing. In some cases we think this is because their management teams lack the understanding about what investors need. In other cases we suspect that they have decided that providing the information will make the loans that they are offering unattractive. In other words, they need to find ‘dumb money’ to make their business model work. 

Too often we see P2P investment sites that just talk about how great each company is, how good their products are and what exciting plans they have. Quite frankly most of this information is meaningless and would be disregarded by any professional investor or credit analyst.

What information is critical?

What information can be ignored?

• What does the business do?
• How much profit or loss has the company made in the last 3 years?
• Are revenues going up or down, and what is behind it?
• What are the assets of the business? How much cash does it have?
• How much debt does the business have? Will this loan increase it?
• How does this loan rank in the capital structure? Do other debts rank senior or junior to this loan?
• What are the projected revenues and profits of the company? What are the key assumptions?
• What is the purpose of the loan? What will happen to the loan proceeds?
• How much net debt does the company hold relative to EBITDA (earnings)?
• Is the loan secured? If so on what? What value will that asset have if the business fails?
• Who are the shareholders? Would they be likely to financially support the business if things go wrong?
• Reviews of the business by its customers
• What are the margins of the business?
• Has the company signed any important new contracts that will grow the business?

• Any risk rating provided by the platform (i.e ‘A1’ etc). Most platforms do not publish how these ratings are calculated, what they mean, and whether they employ any experts who are qualified to determine them
• Any statements about the management that are not explained or supported (i.e ‘Company has a high-quality CEO’). Not reliable
• Any subjective assessments about the quality of the brand or reputation of the business (that’s for you to assess)
• Any comments about the quality of the products or services
• Any statements about the likely future success or prospects of the company

Most P2P sites don’t provide enough information – only a small number do

The vast majority of European P2P investment sites do not provide the information we have listed above. We have been in discussions with the CEOs of several sites to encourage them to improve the quality of information provided. Until that happens we have decided not to list their companies on our site.  We would not invest our own funds in loans we could not analyse properly and we definitely would not want to be seen to encouraging anyone else to do so.

Which sites are at least trying to meet the standard? We’ve been impressed so far with the quality of information provided by the new European site Crowdestate. It provides extensive information on each borrower, is clear on the the structure and use of each loan, and it allows investors to publicly post questions and answers, which provides excellent transparency. Another site that provides good levels of disclosures is the large French/Italian P2P site October. It provides many of the key financial metrics that professional analysts look at and also some fairly good quantitative comments from an analyst. We are not saying that every loan on Crowdestate or October is interesting or a loan that we would purchase, but we do feel that we would have sufficient information to at least make a decision.

How can you avoid being the ‘dumb money’?

Unsecured business loans offer high potential returns but that comes with higher than normal risk. We think that these loans are probably only suitable for one in four P2P investors. For most P2P investors, we would recommend sticking to loans secured by real estate, or highly diversified portfolios that have buyback guarantees (i.e many Mintos loans) or where the risk is pooled (such as Funding Circle).

However, if you have the time and energy to do your own research and analysis, business loans can be a rewarding investment strategy. Just make sure you are able to analyse a balance sheet and P&L and also understand all the key finance concepts such as leverage, debt servicing ratios, security ranking, and so on. Ensure that you have all the information you need, and disregard everything else which in most cases is just ‘advertising’.