5 Reasons To Have Business Loans in a P2P Investment Portfolio
When investing in various asset categories, the effectiveness of P2P investments cannot be ignored. Since the dawn of this investment strategy, many portfolios have been devoted to this approach. In the early days of P2P lending, consumer loans were the primary focus, but as the non-banking financing and P2P sectors evolved, numerous investment options emerged – business loans, real estate, consumer loans, and agriculture asset-based investments.
Business loans are one of the more popular categories of loans. But why should you consider business loans in your P2P investment portfolio?
To answer this question, we have outlined 5 reasons why investing in P2P business loans in collaboration with Debitum. Debitum is currently the leading P2P platform in Europe for SME loans.
1. Transparency
Transparency in any type of investment, be it consumer, real estate, or business loans, is vital for investors. While some investors might be more passive and not delve deep into the specifics of their investments, others are more proactive, seeking detailed information about their investments.
In consumer lending, investors can determine the transparency of platform operations, such as its reporting methods, responses to challenging questions, and licensure. At times, investors may also be able to assess loan originators via their quarterly or annual reports and feedback sessions. However, due to privacy regulations like GDPR, it’s nearly impossible to obtain additional information about the person behind a consumer loan, thereby requiring reliance on the assessments made by the loan originators.
“In Debitum you can find detailed info on the part projects and borrower level. For example, our latest investment assets available in platform comes with detailed description of the business behind the loan therefore investors can understand exactly where they are investing funds.”
Henrijs Jansons, CEO of Debitum
When it comes to business loans, investors often have more access to information to assess their investment performance. For those willing to go the extra mile in ensuring the safety of their investments, there are further ways to gather and evaluate data about their investments, including through annual financial reports, official government websites, and other resources.
2. Diversification
Diversification is widely recognized as a central strategy to manage and maintain investment risk at an acceptable level. In P2P investing, it is impossible to predict the performance of even the most secure asset, loan originator, or platform in the forthcoming years. However, it is possible to significantly lessen the risk of substantial losses from a single poor investment through diversification.
Conventional diversification strategies consist of investing across different asset types such as real estate, stocks, ETFs, cryptocurrency, and P2P loans. However, it is prudent to apply diversification strategies in other areas as well. For instance, avoid investing all the funds in consumer lending, a single country, or an individual platform.
Uncertainties such as economic fluctuations can adversely affect businesses concentrated on a single asset type. In some cases, changes in non-bank financing regulations in a particular country can impact investment returns. Therefore, diversification is crucial even within P2P assets.
Consider spreading your investments across various domains: consumer loans (which offer higher profit and risk), real estate, and business loans (which provide slightly lower profit margins, and longer terms, but notably less risk).
Business loans can be one of the pieces of the puzzle when it comes to diversification.
3. Less risk
A person choosing to invest money in P2P business loans may encounter three types of risk:
- Platform risk
- Loan originator risk
- Underlying asset risk
Investing in business loans generally has a lower level of underlying asset risk than investing in consumer loans because of the different due diligence processes involved. With a business loan, online investment platforms do an onboarding process, which involves a detailed review and assessment of the business’s financials, credit history, and operational risks. This is done to ensure that the business is financially stable enough to repay the loan. Additionally, monthly or quarterly monitoring is performed to make sure that things are still going as planned.
Loan originators follow a similar procedure, regularly communicating with and monitoring the borrower. This means that both the platforms and the loan originators are taking steps to make sure the business is able to repay the loan, which reduces the risk to you as the investor.
“I like how the owner of our LO company “Evergreen Capital” said – “we make sure that each loan we give out is productive loan. It means the money goes into real business, projects, plans”. For businesses, it’s way easy to track performance records than for individuals. Consumer lending companies totally rely on risk algorithms that keep a statistically acceptable probability of default. The moment algorithm faces obstacles that havent been kept in consideration, problems can arise. With businesses, there’s way more “manual work” and “relations”. We know each and every partner. We meet with them, know their business.”
Henrijs Jansons, CEO of Debitum
On the other hand, the due diligence process for consumer loans can be less extensive and therefore poses a higher risk. This is why, on the underlying asset level, investing in business loans can be viewed as less risky compared to investing in consumer loans.
4. Collateral
A business loan is a type of investment that is typically secured by collateral, which can serve as a form of insurance for the investor in case the borrower defaults on the loan.
Collateral is an asset that is pledged by the borrower and can be seized by the lender if necessary. The effectiveness of collateral, however, relies on its reliability and how easily it can be converted into cash.
For instance, collateral in the form of a house or car is more solid and convertible compared to a claim against an individual residing in distant countries like Kenya or Venezuela – which is sometimes what you get when investing in consumer loans.
Business loans, especially on platforms like Debitum, typically involve collateral that can be readily converted into cash. The most common forms of collateral include commercial pledges (e.g., business assets), mortgages, invoices, state-guaranteed tax repayments, and accrued receipts from digital gaming platforms such as Appstore, Google Play, and Steam.
This means that should the borrower become unable to repay the loan, these assets can be seized and converted into cash to offset the loan. This reduces the risk for investors and provides a level of security in addition to the financial strength of the borrower’s business.
5. Returns
Returns from business loans may be slightly lower than consumer loans due to the nature of the loans. But despite the potentially lower returns, business loans are viewed as stable, predictable, and realistic investments due to the ability to assess the health of the underlying business.
As an example, Debitum has an annual return of around 11-12%. Regarding the return of business loans, Debitum’s CEO comments:
“There are clear limits/ceilings in terms of returns we can expect from our loan originators. Consumer loans in Vietnam from end-users can ask for a commission that is measured in a few hundred percent per annum. But when we talk about SMEs in Europe the percentages are realistic and grounded in business health and logic – the average is around 20% per annum. Accordingly, it reflects what are investor returns from business loans – 9-12% per annum (plus campaigns) usually. But the bright side is – we can easily assess how stable and healthy is the business. Therefore these 11-12% per annum are stable, predictable, and realistic.”
Henrijs Jansons, CEO of Debitum
Conclusion
Adding business loans to a Peer-to-Peer (P2P) investment portfolio can indeed be worthwhile. Business loans generally offer higher interest rates than personal loans due to the typically larger loan amounts and slightly higher risk. They also allow for diversification in an investment portfolio, which can help to manage risk.
However, it’s worth noting that investing in business loans also carries certain risks, such as default risk. Therefore, as with any investment, it’s essential to do proper research and risk assessment before you start investing in business loans.
Debitum is considered one of the best P2P lending platforms for investing in SME loans at the time of writing and is one of the highest-rated platforms on p2plendingsites.com. If you are considering adding business loans to your portfolio, you can check out Debitum by clicking the button below: