One of the biggest challenges business owners face is finding the investors they need to secure start-up capital and funding to take their operations to the next level. Online tools such as Peer-2-Peer (P2P) lending have made it easier for company leaders to turn the heads of investors, and these resources could become even more useful, with the UK government’s Innovative Finance ISA.
Connecting with investors
The days where entrepreneurs were restricted to traditional means of getting investment, such as via financial institutions, are nothing but a memory. The digital revolution has provided many new ways for business owners to cut out the middle man and connect with investors directly, so they can find that all important investment without jumping through numerous hoops.
One major innovation that the digital revolution has delivered for investment-seeking business owners is P2P lending. Company heads can use P2P lending platforms such as Zopa and Funding Circle to pitch themselves directly to a large pool of investors online, removing intermediaries such as banks from the equation. The P2P Lending sector has already changed the game for thousands of businesses across the UK, as over £5 billion has already been lent by investors through these platforms.
Providing serious incentive
P2P lending is about to become an even more attractive way of finding investment for business owners, however, thanks to the Whitehall’s new Innovative Finance ISA. It’s a new kind of tax-wrapper, designed to give investors an extra incentive to take a chance on businesses through P2P lending platforms, which are regulated by the UK industry body the Financial Conduct Authority.
The Innovative Finance ISA brings one key benefit for investors — they won’t be forced to pay tax on any interest or capital gains they earn through P2P investments. This is obviously fantastic for business owners because if investors can receive interest and capital gains tax-free, they can maximise their profits, so they are going to be more likely to want to invest in businesses through P2P platforms.
Comparing and contrasting
Getting into the subject a little deeper, any income and gains an investor gains through the Innovative Finance ISA are ring-fenced into a tax-free ‘pot,’ separating them from their other earnings for tax purposes. However, without the Innovative Finance ISA, the investor has to pay tax on any interest they acquire through P2P investments at their income tax rate, and if the interest pushes their total earnings past their existing rate threshold, it could even force them to pay a higher percentage of income tax, making these platforms less attractive for investors who want to earn high profits.
Experts have compared the Innovative Finance ISA to the Cash ISA — standard tax wrappers operated by British financial institutions such as banks. But the Innovative Finance ISA has one clear advantage over its more established rival in the current environment. Innovative Finance ISAs are projected to deliver investors returns of between 7% and 10% — in some cases even higher, but given inflation, Cash ISAs are often resulting in negative ‘real’ returns, due to low-interest rates and rising prices.
Navigating Innovative Finance ISAs
Just as with any other financial product, however, there are a few downsides to Innovative Finance ISAs. One crucial thing to keep in mind is that unlike Cash ISAs, they’re not covered by the Government’s Financial Services Compensation Scheme (FSCS). Without getting into the nitty gritty, this increases risk for investors, as if the business they’ve chosen to back goes under — or even fails to meet repayments, they cannot use the FSCS, which normally gives investors the chance to write off bad debt up to £75,000, in turn making attracting investment via P2P more difficult for businesses.
Another point of interest is that Innovative Finance ISAs are supplied by the P2P platforms themselves, and the landscape is quite varied. Every platform has its own fee structure and lending model — for example, some will charge fees to the lender (i.e. the investor), others to the borrower (i.e. the business), while others still levy fees on both. Depending on the platform, the investor will receive interest according to different payment schedules .e.g. monthly or quarterly, and the differences don’t stop there, so firms need to select the right platform to leverage the Innovative Finance ISA effectively.
Taking advantage of the Innovative Finance ISA
The Innovative Finance ISA could prove a fantastic opportunity for businesses, by making it easier for them to draw investors. It is an attractive product to investors, providing them with desirable tax incentives to invest in businesses, but there are drawbacks, so entrepreneurs should do their due diligence to ensure they find the platform that is best suited to connect them with investors.