Debt Crowdfunding

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careerEver heard of bonds? Well when you buy a bond on the stock market you are basically buying lending money to a company or government in exchange for a promissory note to pay you a set amount of interest on the loan you have given them. The company or government then makes regular interest payments to you. The major risks involved in these investments (and the only risk to your initial capital) are the default risk, meaning if the company does not have enough money to make those payments and or they don’t have enough money to pay back the initial loan either. Your profit isn’t directly tied to the company’s performance and whether or not they have become more or less profitable your capital and interest payments are safe except for a default (see here for more information about what happens when a company defaults). These same risks are present when you buy debt in a crowdfunded real estate project or start-up venture. In many cases though, these projects may have an unproven stream of income making their chances of default much greater. The advantage of real estate debt financing lies in the fact that your capital is usually secured by the underlying asset namely the building or property bought. This means that if the company defaults as a lender you basically have a claim against their assets. Your claim comes before any of the equity shareholders which means that investing in debt is usually much less risky than an equity investment when there is an underlying asset such as real estate.
Aside from the added default risk involved in buying debt from these companies or projects the lack of a secondary market means that if you want to pull your money out and sell the debt you really can’t. Your money is lent to the company and you basically can’t do anything until the loan reaches maturity.
In general feels that buying debt is not really fit for the crowdfunding investor as the risks associated do not justify the returns. Even though there may be real assets securing the loan in general the returns are not very attractive considering the risks of working with unproven platforms and additionally unproven debtors in many cases. Each case though needs to be evaluated individually and depends on the investors as well but since there is really no upside to these investments the returns may not be worth the risk.
In some cases there may be an offer to invest in mezzanine debt financing. This is a subordinate type of debt financing which carries a higher return usually and in case of missed payments allows the investor to convert their debt to equity.