Funding Empire: how you can invest in start-ups and sole traders

Funding Empire is a new peer-to-peer lender that will allow you to put your money into start-ups and sole traders.

If you're interested in peer-to-peer lending instead of (or as well as) other investments and ordinary savings accounts, your choice is growing rapidly. The latest new entrant is Funding Empire.

With Funding Empire, which launches inside the next three months, the interest rates you'll probably be able to charge will be a lot higher than its more established competitors like Zopa or RateSetter. It's normal for investors in newer, smaller peer-to-peer services to demand (and get) higher interest.

This is understandable. There are fewer lenders competing to lend and driving down interest rates, while you don't know how good a brand-new service is at vetting borrowers and you have no history to show it properly segregates your money.

A higher risk proposition

Higher average interest rates before bad debts might be a more or less permanent feature with Funding Empire, since it allows you to invest in riskier propositions than any other peer-to-peer lender that I've looked at closely. Those propositions are start-ups and businesses that haven't even been trading for two years. You can also invest in sole traders and LLPs.

If that's too risky for you, you can also lend to limited companies that have been around a long time. In other words, you could choose to invest in businesses with more of a record to go on.

Loans over £50,000 will always be secured and under £50,000 can be either secured or unsecured. As yet there's little information about the security borrower's require, but directors are expected to personally guarantee all the loans. That means that even if the business fails and can't repay, the directors of those businesses are expected to repay it from their own money. Pretty harsh terms for the directors!

As far as I can see, you can't yet wrap your Funding Empire loans up in a self-invested personal pension (SIPP) to avoid income taxes on the interest you're paid.

Lending costs and minimum investments

You can lend as little as £20 or as much as £2,000 on a single loan lasting anything from six months to five years. Expect to receive less interest for shorter loans.

Borrowers pay a fee of 2% to 6% of the loan to Funding Empire at the outset. This fee is larger for longer loans, and for start-ups and businesses that have been trading less than two years.

You pay no fees if you want to lend on Funding Empire. However, the fact that the borrower must pay a fee might impact on the borrower's ability to be successful and to operate profitably, which could in turn make a default a little more likely.

Your control over interest rates

You can choose what rate you want to lend at, but as usual you're competing with other lenders in a reverse auction. So if many of them offer to lend at lower rates, you could be cut out of the deal.

Sometimes you can expect lenders to offer rates that are too low for the risks involved. You must be more disciplined than them during these times, and refrain from lending. Read a little more on some of those risks in Peer-to-peer investor returns fall to 5.1%.

How you get your money

Funding Empire has provided no details yet, but for now you can assume you receive your returns like you would with most peer-to-peer lenders, in that your borrower pays some interest and repays some of the loan every month, and this lands in your Funding Empire account. You could then withdraw those payments or reinvest them.

At present there seems to be no auto-investing facility to reinvest for you, as with some other services.

Getting out of your loans early

Borrowers can pay off their loans early at no charge whenever they want. If this happens, your loan will be repaid to you, so that you can withdraw it or reinvest it.

If you want to sell your loan to another investor in order to get out early, it is cost-free to do so until January 2014. Thereafter you have to pay 0.25% of the outstanding loan (£2.50 per £1,000) to Funding Empire when you sell.

You can sell your loan at up to a 3% premium (if there is great demand for the loan) or a 3% discount (if the loan now looks too risky or the interest rate is low compared to other loans that are available). This means that if you have £1,000 of a loan outstanding you might be able to sell it for £1,030 or perhaps just for £970.

In the long run I would expect Funding Empire to remove the 3% limit to premiums and discounts, as they are arbitrary and unnecessary, and will one day become unsustainable.

You probably won't be allowed to sell loans that are in default.

You can also buy existing loans from other lenders in the same way, which means you can get lending immediately without waiting for a new loan auction to finish.

How Funding Empire controls risks

Funding Empire looks at the credit score of the business that wants to borrow and its directors. It looks at the business' financial accounts, its payment performance and its existing debts and how these have been serviced. It also “interrogates” the businesses and mentors start-ups to help them get to the stage where they can successfully bid for funding (as well as supporting them “through the loan process and beyond”).

Then it gives you its own risk rating of the business that it passes for investment on Funding Empire. Bear in mind you currently have no idea how good Funding Empire is at rating risk.

You also don't know whether it'll keep its head in the future, even though it refers to its “experienced financial assessment team”. There's no mention of Funding Empire looking at the business plans or trying to assess the chances of success for the start-up, so it can't be a major part of its assessment.

Don't expect Funding Empire to spend hours interviewing all the directors of the borrowers' companies, or days assessing each application or the companies' products. They will not have the time. That's why it's vital that you diversify, especially with the high-risk start-up businesses.

Segregated bank account

As you'd expect, any money you haven't lent out will be held in a segregated client account, at Lloyds TSB.

Bad debts

You get no say over the steps that will be taken to recover money from businesses that default on debts they've borrowed from you. Funding Empire and its collection agencies do it their own way, although this is normal for most peer-to-peer lenders.

Funding Empire has no bad-debt fund to cover defaulting businesses, which means that each investor carries the risks they take when they invest in a business – that business might not pay you all your money back or all your interest.

You get to choose individual businesses

A community bad-debt fund would be hard to make work at Funding Empire – since you can choose your own investments and your investments might be much more or much less risky than someone else's.

You get to look at all the credit reports and financial information that Funding Empire has collected about each business. You can also ask prospective borrowers questions yourself if you want to do your own assessment.

Then you select precisely which businesses you want to invest in. With many peer-to-peer lenders you don't do that, but your money is typically spread more thinly and/or there is a bad-debt fund to cover you from all but the most severe losses.

Making it work

Funding Empire contains no surprises, in that it has many similarities to various competitors, except for the fact you can invest in brand new businesses and start-ups.

Some of the businesses you might invest in here will surely be very high risk. If you choose to use Funding Empire, you might want to avoid investing a large amount in start-ups and other businesses with very short trading records or bad risk ratings. If you invest in busineses with brand new ideas, you should always expect to receive very high interest rates for doing so. 

If you're interested in peer-to-peer lending instead or as well as other investments and ordinary savings accounts, your choice is growing rapidly, which is why I've written about several providers recently:

FundingKnight: new peer-to-peer lender offering 11.4% returns

Mayfair Bridging: new peer-to-peer lender offering 10% tax-free return

Get zero bad debt on Zopa