Thinking of becoming involved in P2P?

Caroline Langron, MD of Platform Black, considers what questions investors should ask in due diligence if they want to become involved in peer-to-peer lending.

Thinking of becoming involved in P2P?

There’s a good reason why financial professionals prefer to talk about risk-adjusted returns: it’s impossible to work out whether a 5% yield represents a triumph or a disaster without considering the risks you took to achieve it. Making 5% a year nowadays on a savings account would be an excellent result; making 5% a year on unsecured P2P lending to very small companies would not look so clever. The point is a simple one: return is what you get after taking the risk.

The online P2P finance platform that I run – Platform Black – provides a valuable service to both sides of the trade but, after more than 30 years working in the traditional invoice finance industry for banks and specialist providers, I am the last person to claim that the process can ever be risk-free.

Stephen Findlay, chief executive of the specialist P2P funder BondMason, said: “P2P lending through an online platform may be a modern activity, but traditional banking should be at its core: people, relationships and a firm understanding of credit is key for a P2P lending platform to be credible and to succeed.”

Institutional investors are responsible for other people’s money and no one enjoys having to explain to a client why a chunk of their cash has gone up in smoke. This is why they think harder than most about the risks they are running and it’s also why the questions they ask as part of their due diligence on any new investment opportunity offer a useful guide for everyone else.

Questions

So what questions should a funder ask if they want to become involved in P2P lending? Here’s a five-minute guide, based on my own experience of due diligence questionnaires and interviews.  A full due diligence pack can easily run to 50 or 100 detailed questions, most requiring documentary proof. But broadly speaking, you can break them down into four main categories.

  • The people and corporate information. Probably the most important aspect for most funders is the team. How experienced are the individuals involved and how robust are the processes that the company follows? Although online P2P finance for companies is a very young industry, the products it offers have been around for decades. Having a senior team with at least 20 years’ experience each – and 30 in my case – is important for our funders and we are frequently asked for our staff’s individual biographies, which we are happy to provide. Some funders will also want to know about the platform’s shareholders, its corporate structure and subsidiaries, as well as who its bankers, lawyers and accountants are.
  • How does the business work? It’s critical that any P2P business can explain exactly what its funders are putting their capital into. What sorts of applicant does the platform accept and reject? What range of deal-size does it fund and over what term? How does it set the interest rates? What rates do companies pay to raise finance through the platform? What gross and net returns do funders make? What fees does the platform charge to each party? Who is liable in the event of a non-payment?
  • Risk management. This is the heart of the matter for most institutions. How does the P2P platform screen companies that want to use it to raise funding? What checks does it run on the directors and owners of businesses that apply to use it? What proportion of applicants are rejected and why? Can the platform document the process it follows to assess the creditworthiness of each business it accepts, and – in the case of invoice discounting platforms – the creditworthiness of the customers that are due to pay the invoices that funders are being invited to buy? How are invoices verified as genuine and how does the platform check they have been received by the customer? What information does it provide to funders about the financial strength and risk rating of each company that raises money by selling its invoices? What security does it take from these companies to mitigate the risk of a default? How does it define vital concepts such as “arrears” and “default”? What process does it have for managing late payments and recovering defaults? What are its current and historic default rates? Can it demonstrate that its investors’ money is segregated from its own corporate funds? What cyber-security measures does it take?
  • Communication: This is absolutely critical to funders. How does the platform communicate with the funder on opportunities, performance and defaults? Does it make clear how to complain and set out details of its complaints policy and processes? What reporting does it make available for funders on the platform? Does it offer guided demonstrations of how the platform works for funders?

As you can see, institutional investors ask huge numbers of detailed questions and platforms must show that they can provide robust answers with documentary evidence to back them up. As part of this process, it is particularly important that potential funders should be able to access detailed and up to date information on arrears and defaults. However, as well as documents and questionnaires, it is also vital that funders are able to meet the people behind a P2P platform face to face so that they can make a judgment about them as individuals and see the team at work close up.

So as we can see successful P2P platforms must aim to foster longstanding, transparent relationships with funders and ensure that they understand the risks and are satisfied with the processes that are used to manage those risks.

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