Equity-Free Investment Strategies: Diversifying Your Portfolio

There are many ways to invest without equity funds. These include loans, grants, royalty financing, vouchers, tax credits, and more. For example, you can use loan agreements, where a bank or financial institution offers a credit line to a startup founder. Another option is to apply for a business grant, which is often provided by philanthropists, government programs, or academic institutions. These grants usually do not need to be repaid and are meant to help entrepreneurs get their businesses off the ground. Additionally, royalty financing involves investors purchasing a percentage of future revenue rather than an equity stake. This allows startup founders to retain control and ownership while still receiving the necessary investment. These are just a few examples of the various options available for investing without equity funds. Each option has its own advantages and disadvantages, so it's important to carefully consider each one before making any investment decisions.

Crowdfunding

There are several types of crowdfunding:

• Equity investment crowdfunding: This involves putting capital into companies, usually early-stage firms, and receiving shares in return. The value of these shares increases if the company does well, similar to regular stocks. However, there is a risk involved due to the unpredictable nature of startups.
• Debt investment crowdfunding: This involves exchanging loans for equity stakes or interest income. Investors can engage with a large group acting as microloan providers, reviewing the loan terms and the borrower's credit rating through an online platform.
• Real estate crowdfunding: This method allows investors to pool their money for real estate projects through online portals. By contributing a smaller amount, investors can potentially earn a share of the profits from rental income or property sales. This approach lowers the barrier to entry for non-accredited investors and those with less capital, allowing them to participate in the real estate market.

Initial Coin Offering (ICO 2.0)

An initial coin offering (ICO) is a fundraising method for new cryptocurrency projects. It is often a form of crowdfunding, although a private ICO that does not seek public investment is also possible. In an ICO, a quantity of cryptocurrency is sold in the form of "tokens" or "coins" to investors in exchange for legal tender or other established cryptocurrencies such as Bitcoin or Ether. The tokens are promoted as future functional units of currency if the ICO's funding goal is met and the project successfully launches.

ICOs are often unregulated and carry high risk. Due to the lack of regulation and enforcement of securities law, ICOs have been the vehicle for scams and fraud. Many countries have banned ICOs, including China, South Korea, Nepal, Bangladesh, Macedonia, Bolivia, and Ecuador.

However, ICOs can be a source of capital for startup companies, allowing them to avoid regulations that prevent them from seeking investment directly from the public and intermediaries such as venture capitalists, banks, and stock exchanges.

To start an ICO, a company must create a cryptocurrency token, set a date, and make rules for the token sale. Additionally, a dedicated team is required to successfully raise funds, and the company must have a cryptocurrency project that people are interested in supporting. A white paper outlining the project, a roadmap with short- and long-term goals, market research on other ICOs, a social media presence, and a marketing campaign are also essential components of a successful ICO.

There are different ways to structure an ICO:

• Static supply and static price: The company sets a specific funding goal or limit, with a preset price for each token and a fixed total token supply.
• Static supply and dynamic price: The ICO has a static supply of tokens but a dynamic funding goal, meaning the amount of funding received determines the overall price per token.
• Dynamic supply and static price: The ICO has a dynamic token supply but a static price, so the amount of funding received determines the supply.

When a company decides to have an ICO, it announces the date, rules, and buying process in advance. Most ICOs require investors to pay using another cryptocurrency, such as Bitcoin or Ethereum, but there are also ICOs that accept fiat money. The purchase process typically involves sending money to a specified crypto wallet address, and investors provide their recipient address to receive the crypto they buy.

The number of tokens sold during an ICO and the token price can be either fixed or variable. For example, a company may offer a fixed number of tokens at a variable price, where the tokens are priced based on the amount of funding received.

ICOs are often compared to initial public offerings (IPOs), as both allow companies to raise funds. However, IPOs involve selling securities and are subject to stricter regulations, requiring companies to file a registration statement and obtain approval from the U.S. Securities and Exchange Commission (SEC). On the other hand, an ICO is the sale of a cryptocurrency, not a security, and does not have any formal requirements.

Despite the risks and lack of regulation, ICOs have been extremely popular, with a record $7 billion raised via ICO from January to June 2018. Notable examples of major ICOs include Ethereum, Cardano, Tezos, and Dragon Coins.

Debt

There are several types of debt financing available:

• Business lines of credit
• Business credit cards
• Personal loans, usually from family or friends
• Peer-to-peer (P2P) lending services

Another form of debt financing is through debt mutual funds. These are a type of mutual fund that invests in debt instruments such as bonds, government securities, and corporate debt. Debt mutual funds offer fixed returns and are considered less risky than equity investments, making them attractive to investors with a lower risk tolerance. However, debt mutual funds also tend to offer lower returns compared to equity investments.

When considering debt financing, it is important to evaluate the interest rates, fees, and potential risks involved. Additionally, businesses should have a clear understanding of their financial situation and ensure they can manage the debt without impacting their operations.

Overall, debt financing can be a viable option for businesses seeking funding while retaining control and avoiding the dilution of equity.

Real Estate Investment Trusts (REITs)

REITs are typically traded on major stock exchanges, just like stocks, and they offer a number of benefits to investors. Firstly, they provide a way for investors to earn a share of the income produced through commercial real estate ownership. Secondly, they are an excellent portfolio diversifier due to their low correlation with other assets, helping to reduce overall portfolio risk and increase returns. Thirdly, they have historically delivered competitive total returns, based on high and steady dividend income, with the potential for long-term capital appreciation.

There are two main types of REITs: Equity and Mortgage. Equity REITs own or operate income-producing real estate, while Mortgage REITs provide financing for income-producing real estate and earn income from interest on these investments.

When considering investing in REITs, it is important to understand the benefits and risks. One of the risks associated with non-exchange-traded REITs, also known as non-traded REITs, is the lack of liquidity. These REITs are illiquid investments and cannot be easily sold on the open market, which may pose a challenge if quick access to cash is required. Additionally, determining the share value of non-traded REITs can be difficult as they do not provide an estimate of their value per share until 18 months after their offering closes.

To qualify as a REIT, a company must meet several requirements, including investing at least 75% of its total assets in real estate and deriving at least 75% of its gross income from rents or interest on mortgages related to real property. They must also pay out at least 90% of their taxable income to shareholders in the form of dividends.

REITs provide a unique opportunity for individuals to invest in real estate without the need to directly purchase and manage properties, offering both growth and income potential.

Peer-to-peer lending

Peer-to-peer (P2P) lending is a type of investing that has been around for centuries, but it has evolved from local practices to global online platforms. P2P lending is a transaction between two parties: the lender (investor) and the borrower. Lenders provide loans to earn a profit, while borrowers can use the funds for various purposes. P2P lending usually involves fully amortizing, fixed-rate loans with constant interest rates and equal instalment payments according to set schedules.

How it Works

Borrowers submit applications that include basic information such as the requested loan amount, the purpose of the loan, and their credit history. Loan terms typically range from three to five years, with an average interest rate of 6.99%. Borrowers are rated according to "credit grades", with parameters including their FICO score, debt-to-income ratio, loan amount, loan purpose, and desired loan term. The minimum credit score is generally in the mid-600 range, and individuals with recent bankruptcies or tax liens are usually excluded.

Investors can choose to fund entire loans or parts of loans. Funding parts of loans is generally recommended to reduce the risk of losing your entire investment if a borrower defaults. Notes can be purchased for as little as $25 each. The P2P platform handles administrative tasks such as underwriting, closing, and distributing loan proceeds, and lender remuneration, typically in exchange for a 1% administrative fee. Some investors report average annual returns of more than 10%.

Types of Loans

Personal loans are the most common type offered by P2P platforms, often used for debt consolidation or home improvements. Auto loans are another popular option, with a ceiling of $35,000, which can be used to purchase a vehicle. Business loans from P2P sites tend to have more relaxed requirements and less documentation than bank loans, but most sites require borrowers to have a track record of at least six months. Mortgages and refinancing options are also available, usually for owner-occupied residences. Student loan refinancing is another specialty, allowing students to combine loans from multiple lenders. Medical loans can be applied to dental work, fertility treatments, hair restoration, and weight-loss procedures, which are often excluded from typical insurance policies.

Pros and Cons of P2P Investing

Pros:

• Low Barrier to Entry: P2P portfolios can be created with minimal capital, making it a cost-effective investment option.
• Monthly Income: Investors receive payments each month as borrowers make payments on their loans, providing a steady stream of passive income.
• Higher Yields: P2P lending offers the potential for higher returns, with carefully curated portfolios earning 10% or more annually.
• Specific Control: Investors can choose the types of loans, credit score ranges, and debt-to-income ratios of borrowers they work with.
• IRA Friendliness: Some platforms offer the ability to set up standard or Roth IRAs or roll over 401(k)s, providing tax advantages.
• Loan Diversification: Investors can fund entire loans or purchase notes in small increments to spread risk across multiple loans.

Cons:

• Potential Defaults: Most P2P loans are unsecured, with no collateral, and are given to individuals. There is a risk of losing your investment if a borrower defaults, especially early in the loan term.
• No FDIC Protection: The Federal Deposit Insurance Corporation does not reimburse investors if P2P platforms or borrowers default.
• Capital Depletion: Principal and interest payments are recovered simultaneously, which differs from traditional securities where the original capital is returned at the end of the term.
• Lack of Liquidity: The secondary market for P2P loans is currently limited, so P2P investments are typically long-term commitments.

Tips for Successful P2P Investing

To minimise risk, diversification is key. Invest in a variety of loans and spread your capital across different credit grades. Remember that risk and reward are correlated, so a balance is necessary. Keep P2P investments to a small percentage of your fixed-income investments. Reinvesting loan payments is also crucial to maintaining a long-term P2P strategy, as returns diminish as loans get closer to their term.

When choosing a P2P platform, carefully research the risks, loan terms, penalties, and impacts. Understand the protections in place for both borrowers and lenders. Ask questions about the risk of investing, penalties and fees, loan terms, and the potential impact on borrowers. Ensure the platform complies with relevant regulations to protect your investment.

Frequently asked questions