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The pros and cons to alternative investment in to private companies via debt or equity

Posted 26 days ago

The pros and cons to alternative investment in to private companies via debt or equity
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At the advent of NextFin, the first crowdfunding aggregator, I was so excited about the future of private investment into companies whether it be equity or debt. I envisaged a world where normal run of the mill people could benefit from the high returns private finance companies, venture capitalist and high net worth investors were achieving. There was now choice, no longer was it just a Pension or an ISA that was available for you to invest in. The lay-man or (woman) school teacher, nurse, policemen, whatever your background, could take some risks and invest in private companies via a platform.

However, it's scary. Investing in the private world can be the wild west and although the returns can be very enticing you need to remember this is where you can lose it all. There is no compensation scheme so this is not a place to invest your life savings. In-fact the FCA regulates many of these platforms and asks them to make sure that you do not invest more than 10% of your net worth and many platforms will only accept professional or high net worth investors. 

Many viewed the growth in crowdfunding and direct private investment as the democratisation of finance and the birth of a new private stock exchange where loan notes and shares could be exchanged in private companies.  Even though the alternative finance marketplace has been around for nearly 10 years and is growing. It is still young and there is little liquidity in the market so it can be hard to get your money out once it is in. Having said that, on the debt side we have seen many successes where investors have achieved the target rate of return advertised and we have seen a few exits on the equity side.

So let's go over some of the main Pros and Cons. This is not advice, just a guide and some tips. If you are not an experienced investor, always seek professional advice.

Exciting and Altruistic

Pro

It's exciting and you are often investing in young companies helping them grow.

Con

Because they are young, sadly this is a high risk situation and if they don't manage the money correctly or the project fails the company could fail.

What to look for:

Look at the management, the product and the cash flow. Do they have the experience, has the product been tested and is it selling, is their balance sheet strong and can they weather the storm if it is not successful.

Interest

Pro

It could pay high returns in interest.

Con

High interest normally means high risk: for example if you have a good credit rating you pay low interest, high risk borrowers pay higher rates. 

What to look for:

Look at the track record of the company or platform. The platforms generally only want successful loans or projects on their platform but they still have failures like anyone else.

How long have they been doing this and check Google for their reviews, failures and successes.

Diversification 

Pro

Investment 101 is to diversify and it's healthy to invest across a broad spectrum of opportunities from high and low risk to different sectors. If one sector goes down, you're hoping another goes up. The majority of your money should be low risk. Many platforms allow you to do this and some will do it for you.

Con

It can be difficult dealing with multiple investments and The FCA recommends only 10% of your net worth should be invested in alternative finance because it is high risk.

What to look for:

Don't put all of your 10% in one platform or one deal. Spread the risk. Look for platforms that offer multiple opportunities and invest across a few different platforms to minimise the risk.

Debt Investment

Pro

The great thing about debt investment is you have a predefined exit. Meaning there is a predefined time of when you get your money back and it is usually being paid back to you on a monthly basis. 

Con

Your capital is still at risk if the entity you are lending your money to fails.

What to look for:

Investigate the security behind the investment is it sufficient enough to pay the debt off if the company cannot afford to repay the loan.  

Equity investment

Pro

The great thing about equity is that you own a part of the business and if it is an EIS/SEIS business. The investment comes with tax benefits where you can claim credits and losses from the government depending on your circumstances.

Con

You could lose all of your money if the business fails.If the business is not EIS approved or changes its business model and fails you may not be entitled to the tax benefits.

What to look for:

Check with your accountant to see if you are eligible for the tax benefits, check the company has EIS advanced assurance, make sure the shareholders agreement has guarantees that the company will not change its model so that it doesn't disqualify its EIS status.



Private investment into businesses whether it be loans or equity has been known to provide good returns but for every major success there are lots of failures. Many experienced investors apply the logic of investing only 10% of their networth into this area because of the risk associated with it. But that's not to say they don’t love it. 

Remember, the above is not advice, just a guide and a few tips on what to look for. It’s always good to get professional advice before investing. 

Author: Sacha Bright, CEO of NextFin

Disclaimer: To the best of our knowledge, the information we have provided is correct at the time of publishing. Sacha Bright is not a solicitor or accountant and we recommend that you seek professional advice on any topic discussed. NextFin is not liable for any damages arising from the use of or inability to use this site or any material contained in it, or from any action taken as a result of using the site.

Tagged: investment guide alternative finance debt equity advice pros and cons



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