Gross / net return on crowdfunding: what’s the difference?
You’re thinking about investing money in a business loan through crowdfunding. Then, of course, you want to know what return is realistic. In this article we explain the difference between gross and net returns. We also tell you about the risk and why you should spread your investment.
Gross and net return on crowdfunding
When you invest, you lend an amount of money to an entrepreneur. This entrepreneur lends this amount for a project. Think of expansion, company takeover, working capital and growth financing. You often invest together with other investors on a crowdfunding platform. Each investor provides part of the total amount of a self-selected business loan for a fixed term.
During the time you have lent out your money, a company pays interest on the loan amount and redeems the loan. The interest rate and the duration of the loan are known before you decide whether you want to invest. The interest rate and the duration of the loan are known before you decide whether you want to invest. Among other things, the monthly interest a company pays on the loan and any write-downs determine your return.
What is return?
Return is another word for profit. This profit usually arises because a company with a loan pays a prearranged monthly interest rate on the amount you have lent out. You only make a profit if a company pays interest every month on the amount of money you have lent out and you get your deposit back in full at the end of the term. This is not guaranteed.
Difference between gross return and net return
There is a difference between gross return and net return. The net return is the amount you actually receive as profit. This does not include the repayment of your loan, as this is a repayment. To explain to you how a net return is achieved, we first have to talk about gross return.
What is the gross return of an investor?
Your gross return is a calculation and depends on the loans you have invested in: your portfolio. Summarised in one sentence, it is a pro rata calculated average of the interest income from your portfolio. This means that if you invest more money in loan A than in loan B, loan A will weigh more heavily in this average.
The intention is for an entrepreneur to repay the loan on a straight-line basis. Linear means that the amount that an entrepreneur pays off each month is the same over the entire term. He pays you back a part in instalments (every month).
This also means that the amount you lend out becomes less and less and your gross return changes every month. An entrepreneur pays a little less interest every month because the outstanding amount becomes less due to the monthly repayment.
What is the net return of an investor?
The costs you incur as an investor to achieve your return are not included in the gross return. This amount is deducted from your gross return. You also have to deduct any write-downs. The result of this calculation is your net return. The net return is lower than the gross return because you incur costs.
Investing in business loans: risk
The loan agreement you enter into with the entrepreneur states that you will receive your deposit back during the term of the loan. If a company is unable to meet its payment obligations (e.g. in the event of bankruptcy), it is possible that you will not receive your deposit back, or not in full. It is also possible that the interest – and therefore your return – is not paid by the entrepreneur.
Risk in the event of default
So there is always a risk involved in investing in business loans. If an entrepreneur fails to meet his financial obligations, this is called default in technical terms. In such a situation, you may not make a profit, but run a loss. You may also lose your investment.
Security rights and payment agreements
Of course Knab does everything in his power to prevent this from happening. For example, we only offer loans that we think you can make a well-considered choice. There is also always collateral for a loan. Often this is in the form of security rights. For example, on the entrepreneur’s inventory.
If the entrepreneur fails to honour his payment agreements, the inventory can be sold, with the proceeds being used as much as possible to pay the overdue interest and repay the loan.
Example: consequence of a default
Suppose: Hannah invests equal amounts of € 100 in 10 loans, all running for 5 years. If one of those loans goes into default halfway through the 5 years, 50% of the deposit is gone (€ 50). The entrepreneur has already repaid the remaining € 50 to Hannah in the first 2.5 years of his repayment.
Subsequently, the crowdfunding platform can still recover an amount by extracting the securities. In this example this is 25% of Hannah’s investment, but in reality this could also be a lower percentage. This makes the total that Hannah gets back € 75, plus the return over the first 2.5 years of the loan in question.
Hannah thus loses € 25 on its original investment in this particular loan. This means a loss of 2.5% of her total investment of 10 x € 100. Fortunately, Hannah has spread her investment over 10 loans. Also due to the return on the other loans in which Hannah has invested, Hannah ultimately does not suffer a loss on her entire portfolio. Indeed, she absorbs the loss on this loan with the returns on the 9 other company loans. However, her net return will fall as a result of this default.