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We have dedicated a three-part blog post series to explain how crowdfunding and P2P platforms work. In the first blog post, we talked about the platform’s operating company and its management and key people.
Read “Part 1a: Platform operator“.
Read “Part 1b: Management and key people“.
The second part of the best practise guide for crowdfunding and P2P lending platform is focusing on processes.
1. Due-diligence, transparency and information completeness
As any other investment activity, investing through crowdfunding platforms should be rational, informed and focused choice. All investment opportunities are different both qualitatively and quantitatively and the list of differences is almost unlimited for instance duration, risk, repayment schedule and interest rate.
The decision of whether or not to invest is in the hands of each individual investor. It is therefore essential to know investment opportunities’ all relevant details and have access to as much information as possible to make an informed choice.
Keep in mind that the loan will be repaid by the Sponsor of the investment opportunity, not by the crowdfunding platform (which has only a “showcase” or “intermediary” role).
Main things to keep in mind:
The reliability of the project and of the Sponsor company could be verified when the platform publishes a complete analysis of the project, with enough detailed information about expected costs, projected revenues along with the market and competitive analysis (the so-called “comparables”, for the real estate market).
As an example, at le1ast the following information should be made available for a real estate project:
- Sponsor analysis to ensure the Sponsor has an adequate track record and competent management team in place. It is essential that they present themselves and put their face on it.
- Clear project description to give the investor an overall understanding of the project.
- Detailed business plan, including estimated costs and revenues, to validate the project cost base and revenue projections, and as a result of that, the Sponsor’s capability to return the raised capital and its interest.
- Market and comparables analysis to validate the demand for a specific property at the specific location at the estimated price point.
- Cash flow analysis to demonstrate that the company will at any time point have all the necessary liquidity to meet its expenses.
- Capital structure analysis to ensure the Sponsor has enough “skin in the game” by having its real equity in the project and that the project’s capital structure would be aligned with the development state and specifics of the project.
While there are dozens of crowdfunding platforms out there, doing no due diligence at all or just focusing just on the loan collateral values, Crowdestate has believed that good investment opportunities can be identified only via comprehensive due diligence and analysis process.
Our thinking and opportunity selection process is outlined below:
- Our starting point is always focused on the Sponsor of the investment opportunity to verify his clean background, track record and the project team. However good the investment opportunity itself might be, an untrustworthy Sponsor, the lack of a competent team or track record could totally ruin it. Weak result of Sponsor’s qualitative analysis is always resulting in rejection of the investment opportunity without proceeding into other areas of due diligence.
- If the investment opportunity passes the Sponsor analysis phase, our next focus area is the investment opportunity’s product and location analysis. The aim of this analysis stage is to understand the project and its key selling arguments, as well as evaluate the investment opportunity’s location and its fit with the planned product. The key items covered in the product analysis would be the gross buildable and net sellable area, number and sizes of the future units, parking facilities, key pricing indicators (average prices, unit prices, key pricing ratios) and key sales arguments. The location analysis provides answers to questions related to the property itself and the attractiveness of its location. We start from a high-level view, looking at the whole region, then zooming in to the city and then on a district level, paying attention to the current and future infrastructure and then forming a subjective conclusion on the attractiveness of the location.
- The third focus area is the market fit, which focuses on the product and its current and future-fit to the market. Competitive analysis monitors the current and future known competitors in the specific segment. The aim of our market and competitive analysis is to determine if there is and/or could be adequate demand for the project at the projected price level. This stage takes a look at different market statistics and trends, including macroeconomic indicators and population change trends, ending up with the identification and analysis of different direct competition.
- The fourth analysis area is the investment opportunities’ financial and cash flow analysis, which allows us to understand the investment’s capital structure and its financial feasibility. One of Crowdestate’s core beliefs is that all projects should be capable of generating enough cash to repay the attracted capital and investors returns without the need to rely on the forced liquidation of the collateral. Financial and cash flow analysis results in a comprehensive cash flow plan complemented by a set of business and risk ratios.
- We believe a proper capital structure is the foundation of any real estate project, and that the Sponsor should have significant skin in the game. Inability to demonstrate the required level of Sponsor’s own equity results in immediate disqualification.
- The last step in the process is to determine the availability of collaterals that would secure Crowdestate’s investors’ investments. Typical collateral is a 1st or 2nd lien mortgage established on the property, but we all other collaterals (such as personal guarantees, mortgages on other properties, share pledges etc) are welcome.
After completing our due diligence, we are able to evaluate the overall risk/return profile of the project and establish the justified expected rate of return that the investors would expect from investing into this investment opportunity.
The summary of our due diligence results, detailed cash flow projections, property evaluation documents etc are published next to the investment opportunity so any investors looking to dig into details, is able to do that.
b. Deposits and withdrawals
In the age of digitalisation, anything less than 24/7 access and instant payment execution capability is a sign of something not designed or executed right. As an investor, you would like to see your payment is credited to your investment account as soon as it arrives at the crowdfunding platform operator’s client account, and you would expect that you can withdraw your investment account’s cash balance any time and without any delays.
We can not hide our daze hearing stories about investors, who are struggling with some P2P platforms to withdraw their cash balances and where the payment execution takes days or weeks. The lack of immediate withdrawal execution is a major red flag, indicating one of the following problems:
- In the best case, the P2P platform’s technical capability is so undeveloped that the execution of payments need “human interface” manually sending the withdrawal orders to their clearing bank;
- In the worst case, the P2P platform has no segregation of their own and investors funds, and have been using investors’ funds to finance platform operators business expenses, meaning there is not enough cash on the platform to fully execute all withdrawal orders as they are submitted. The withdrawal orders could be then executed only when new investors are adding funds to the P2P platform or some investments are paying interest or repaying principal.
As an investor, you should avoid investing on platforms that can not clearly demonstrate the segregation of their own and client funds and that can not promptly execute your withdrawal orders.
Crowdestate has been applying the strict cash account segregation policy since the foundation of the company. Our deposits and withdrawals features are available 24/7 and our technological design includes several audit and control layers to ensure that the client account cash balance at our clearing bank is always equal to the total sum of cash balances on all investment accounts. This means that Crowdestate is capable of executing each and every cash withdrawal order even in the case where all investors would decide to withdraw all their cash at the same time.
Our platform technology has an online link to our clearing bank, and all incoming payments are credited to investors’ investment accounts automatically as soon as they arrive at our client account. The only exception here is the case when the payment arrives to us without important details (for example, an individual reference number), causing the payment to be directed to the manual verification stage to ensure the funds are credited to the correct investment account.
The cash withdrawal orders are accepted at the moment they are submitted to our and sent to the outgoing payment queue. Due to both our and our clearing bank’s security policy, the outgoing payments need additional digital approval by one of our members of the management board. We do it several times a day, from the start and until the end of the working day. According to our Terms and Conditions, we have established the outgoing payments to have a cut off time of 15:00 EEST and we guarantee that all withdrawal orders submitted to us before that time are executed the same day. This means the investors’ withdrawal order ends up in SEPA clearing the same banking day, and there are 2 clearing times remaining for the day. This ensures the investor’s funds should arrive at the investor’s EU bank account the same day. While the withdrawal orders submitted to us after 15:00 EEST are still approved the same business day, they might miss the last SEPA clearing cycle and therefore would arrive at the investor’s EU bank account probably before noon next banking day.
Some countries, like Estonia, have implemented 24/7 flash SEPA payments, which means that the funds sent to investor’s investment account with Crowdestate would arrive there in less than 10 minutes, and they would be back on investor’s EU bank account within few minutes after the outgoing payments have been approved by Crowdestate.
We encourage you to test out payment processing capability by sending a small payment (for instance, EUR 1) to your Crowdestate investment account. Depending on your bank’s payment processing capability, it might take from a few minutes to a few banking days for the funds to arrive. As soon as the funds arrive to your investment account, we will email you a credit notice (unless you have switched the feature off). This will allow you to establish a normal timeline for the payment to arrive. Reverse the process by submitting the funds’ withdrawal order to see how quickly the funds leave your investment account and when they arrive to your EU bank account.