The Many Shades of Online Financing Platforms
Two years ago I wrote a blog about the word crowdfunding, and how the explosive growth of the industry meant that "crowdfunding" was being used as a blanket term to describe all types of online fundraising efforts.
Two years later, the online financing industry continues to expand rapidly as does its terminology. Not only are there different terms for "crowdfunding," but there is also a range of terms emerging to describe alternative financing platforms.
If you are a self-directed IRA owner and you want to invest your IRA funds, it's important to understand the nuances of these online financing models. Each one comes with its own risk and potential returns, and it's crucial to understand the differences if you plan on handing over your retirement funds.
While you should always do your own due diligence, here is an overview of some of the most popular types of online financing models:
- CROWDFUNDING: When people hear the word crowdfunding they often think of rewards-based crowdfunding that has been championed by Kickstarter or Indiegogo. Participants donate money online to support to a fledgling business or product. In return they might receive a reward, like early access to a product when it's released. But participants may not receive anything at all, and making a donation does not translate into an ownership stake in the business. While this type of online financing is not eligible for the use of IRA dollars, it is sometimes confused with the next type, which is.
- EQUITY CROWDFUNDING/CROWDFINANCING: Equity crowdfunding or crowdfinancing goes beyond making a donation to making an investment. Equity crowdfunding campaigns give backers an ownership stake in the business or the fund, qualifying as a type of private placement investment. Making an equity crowdfunding investment should be taken as seriously as any other investment in your retirement portfolio.
- DEBT CROWDFUNDING: In debt crowdfunding, an investor lends money that will be used to fund a project, often a real estate-related one. Typically a crowdfunding portal “prefunds” a loan, and you invest in a borrower payment dependent note—BPDN—between you and the portal. The note acts like a fixed income investment, with a stated interest rate and term. The unsecured note is dependent on payment of the underlying loan between the portal and the developer/borrower. As an investor, you generally have no security in the underlying property.
- PEER-TO-PEER LENDING: Peer-to-peer lending (P2P) is another form of debt financing. P2P lending emerged as a way of allowing individuals to borrow and lend money to one another using an online platform, which streamlines the process compared to a loan funded through a traditional lender. Lending money through a P2P platform provides the potential to generate income in the form of interest, but such returns are entirely dependent upon the borrower making payments on these unsecured loans.
- MARKETPLACE LENDING: Marketplace lending is an evolution of P2P lending. Rather than individuals lending money to one another, marketplace lending connects consumers and small businesses that need to borrow money with individuals and institutions who loan money. Investors commit funds toward loans, and expect to earn interest and/or principal payments depending on the structure of the note.
Many in the industry today refer to these models with the umbrella term "investment platform," and the platforms tend to differentiate themselves by focusing on the type of investment opportunities they offer.
For instance, IRA investors who specialize in real estate are often drawn to investment platforms that specialize in real estate deals—whether that means a platform offering equity crowdfunding opportunities or debt crowdfunding ones. Investors unsure of where they want to invest may seek out a marketplace platform that provides access to deals across a wide range of industries.
When vetting alternative financing platforms, it's important to determine whether the platform is open only to accredited investors or whether it allows non-accredited investors. While the JOBS Act allows the general public to buy shares of private companies that are issued on securities crowdfunding platforms, that does not mean platforms are required to be open to non-accredited investors.
Keep in mind that many of these emerging alternative financing platforms are new and involve risk. Like any other investment you make in your self-directed IRA, there is no guarantee you'll receive a return on your investment and you may lose your capital. Due diligence is a must, and it's highly recommended that you work with your financial advisor to understand any investment you are considering.
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This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.
PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. PENSCO is indirectly affiliated with a registered broker dealer and with a licensed small business investment company through Opus Bank (“Opus Affiliates”). Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.