ALTERNATIVE INVESTMENTS

With the sour taste that venture capitalists and investment bankers have left in the mouth of many aspiring entrepreneurs, it's no surprise a new way of investors directly funding businesses is taking off...and every investor should know about it, writes Doug Hornig of Casey Research.

Back in the 1960s, a clever but financially disadvantaged fellow placed a small ad in a national magazine that read something like: "Money needed. Please send $1 to the address below. Do it today!"

No specific need was given, and nothing was promised in return, so that fraud could not later be charged. Yet within a few months, thousands of dollars arrived in his mailbox, a considerable sum in those days. Or so the urban legend goes.

P2P Money
A half-century later, many things have changed, but one thing remains unchanged: People still need money, and they have not ceased to innovate ways in which to get it.

We have written extensively in this space about many of the P2P Internet connections that are transforming the planet... in commerce, in education, in the job market, and with business and social networking. The list of possibilities is truly endless.

For yet another example, the world of money has been given a Red Bull jolt by a fast-growing phenomenon known as "crowdfunding."

Previously, if you had a grand scheme for a new product or service and you needed seed money to get your project off the ground, you had to save it yourself, borrow from friends and relatives, or go with begging bowl to your local bank, which was unlikely to see you as the next Steve Jobs. If it was a big enough idea, you might even attract the attention of a venture capital (VC) company, but there you had to be prepared to offer many pounds of flesh in return.

And still, those ideas that didn't meet with bank criteria (there's no collateral for a software startup), yet weren't large enough for the VC crowd often fell into a no man's land, scraping out some funding from unorganized, so-called "angel" investors, or never getting funded at all.

More recently, we've seen the rise of for-profit Internet alternatives to traditional lending, such as Prosper, Zopa, and the market leader, LendingClub. These P2P companies specialize in small loans—LendingClub's limit is $35,000.

They don't originate loans—they facilitate them, cutting out the banks and creating a situation that allows individuals with spare cash directly to invest in other people's dreams, while the dreamers can borrow based on the public responses to their particular (hopefully compelling) stories. For each loan, there is a multitude of lenders, not just one.

It's a win-win proposition. Borrowers receive below-market rates with less hassle than is usually encountered at a traditional financial institution. Investors get an excellent rate of return, and can attenuate risk by building a portfolio spread across multiple loans. And LendingClub prospers by taking a cut.

The site claims a very low default rate of less than 3% since its inception in 2007, and it has been a monster success. To date, LendingClub has negotiated nearly $1 billion in loans, a meteoric ascent from about $175 million just two years ago.

Other, more philanthropically oriented organizations either are or function a little more like nonprofits. They solicit donations in order to make very small micro-loans to budding entrepreneurs, primarily in the developing world. Donors either simply get their money back, or the principal plus a small amount of interest.

Those that work this way include Kiva, Zidisha, Fundable, PayPal's MicroPlace, GlobalGiving, FirstGiving, CreateaFund, Calvert Foundation's Community Impact Investing, and the Grameen Foundation, which received tremendous worldwide publicity when its partner organization Grameen Bank shared the Nobel Peace Prize with founder Muhammad Yunus in 2006.