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Guide to Peer-to-Peer Business Lending

Peer-to-peer (P2P) business lending is a relatively new form of financing that connects business borrowers directly with individual and institutional investors looking to fund loans. This model cuts out traditional financial institutions as the middleman, allowing for more efficient lending and potentially better rates for borrowers.

Overview of P2P Business Lending

The basic premise of P2P business lending is simple:

  • Business owners apply for a loan through an online P2P lending platform like Lending Club, Funding Circle, or Ondeck.
  • Investors review loan applications and invest in ones that meet their criteria. This allows the loan to be funded by many small investments rather than one large lender.
  • The P2P platform services the loan by collecting repayments and interest and distributing payments to investors.

This model helps small businesses access loans that may be unavailable through banks while giving investors higher returns than other fixed-income investments.

Benefits for Business Borrowers

P2P business lending offers several advantages over traditional bank loans:

Faster Application and Funding

The online application process is much faster with minimal paperwork. Loans can often be funded in just 1-3 days instead of weeks or months. This increased speed meets the need many small businesses have for quick capital in order to grow or manage cash flow.

Lower Interest Rates

By avoiding high overhead costs of banks, P2P lenders can offer lower rates, often in the 5-9% range compared to 10-30% for bank loans. Better rates make financing more affordable.

Flexible Loan Amounts and Terms

Loan amounts range from $5,000 up to $500,000+ with varied repayment terms from 6 months to 5 years. Businesses can find a loan tailored to their needs.

Expanded Qualifying Criteria

P2P lenders look beyond credit scores at the overall health and growth potential of a business. This helps more companies qualify, including newer businesses with limited operating history.

No Collateral Required

Unsecured P2P business loans do not require collateral like real estate, equipment, or investments. This greatly expands access to capital for early-stage and service businesses.

Risks of P2P Lending

While P2P lending offers clear benefits, business owners should also carefully consider the risks:

Higher Rates for Riskier Borrowers

Interest rates are tiered based on risk level from 5% for the most creditworthy borrowers to 30%+ for those with poor credit or an unproven business. Rates may also rise over time after an introductory period.

Missed Payment Penalties

Late or missed payments often trigger expensive fees and sharply higher interest rates. This can quickly spiral financing costs out of control.

Lack of Flexibility in Hard Times

Unlike a bank, P2P lenders have less ability to renegotiate loan terms if a business struggles temporarily. Missed payments sink credit scores and cut off access to reasonable financing.

Less Historic Data on Defaults

P2P lending has far less track record on defaults compared to banks with decades of loan data. Actual default rates may end up higher than estimated.

Investor Funds Can Dry Up

Market volatility or rising defaults may suddenly chase away P2P investors. Without investors, platforms struggle to fund new loans just when small businesses need financing the most.

Tips for Getting a P2P Business Loan

If you determine P2P business lending aligns with your financing needs and risk tolerance, here are some tips for getting approved:

Check Personal Credit Scores

Your personal credit will be checked and is a major factor in loan decisions, especially for newer businesses. Ensure any errors are fixed and maintain low balances on credit cards.

Get Your Business Financials in Order

Provide several years of tax returns, bank statements, profit/loss statements, accounts receivable/payable aging reports, and other documentation to prove your business model and revenue stability.

Focus on Business Growth Potential

Emphasize how the loan will fuel growth plans to increase revenue, enter new markets, launch products, etc. Back this up with financial projections.

Apply to Multiple Platforms

Each P2P platform has a different mix of investors with varying risk appetites. Applying to several sites improves your chances of funding.

Consider a Co-signer

Adding a creditworthy co-signer may help you qualify if you have limited personal or business credit history. Offering collateral like equipment or securities can also offset risk.

Watch Out for Origination Fees

Some P2P lenders charge upfront origination fees of 2-7% deducted from the loan amount. Avoid fees over 5% as this erodes potential savings.

Questions to Ask P2P Lenders

As you evaluate P2P lending platforms, ask these key questions:

  • What are the rates/terms for borrowers with my credit profile?
  • What percentage of loans are eventually funded and how quickly?
  • What is the application process and what documents are required?
  • Are there any upfront or prepayment fees?
  • What happens if I miss or delay a payment?
  • Can loan terms ever change regardless of payment history?
  • What support is offered if I struggle to make payments?
  • What is the procedure and timeline if I default?
  • Who are the investors funding loans?
  • What is the default rate and investor loss rate?
  • How long have you been facilitating loans?
  • Are you profitable as a company?

The answers will help you ascertain if the lender is reputable and meets your financing needs.

Alternatives to P2P Lending

If you are uneasy about putting your business in the hands of faceless P2P investors, some alternatives to consider include:

Online Business Loan Marketplaces

Sites like Nav and Lendio let you compare loan offers from multiple competing business lenders including banks, credit unions, and alternative lenders. This simplifies finding the best rates/terms.

SBA Loans

The Small Business Administration guarantees portions of bank loans to qualifying businesses, helping entrepreneurs secure reasonable interest rates based on the government backing.

Invoice Factoring

Factor companies provide financing by purchasing your outstanding customer invoices. This turns unpaid invoices into immediate cash flow minus a fee.

Angel Investors and Venture Capital

Equity financing sells a stake in your startup’s ownership rather than taking on business debt. This aligns investor returns with your success.

Crowdfunding

Platforms like Kickstarter and Indiegogo let you pitch your business directly to potential backers to raise startup or growth funds through many small contributions.

The Bottom Line

P2P lending provides a valuable new option for small business financing with faster approvals, lower rates, and expanded qualifying criteria. However, the model also comes with distinct risks if business conditions deteriorate. Business owners should carefully assess their ability to manage higher payments and increased costs if difficulties arise before committing to P2P loans. With realistic planning for the downside risks, P2P lending can be an affordable financing catalyst to start or grow many types of small businesses.

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