Is Peer-to-Peer Lending Right for My Small Business?An industry expert explains why this financing option may be a smart way to secure a loan.
Peer-to-peer (P2P) lending is a relatively new loan option for small businesses, but it already accounts for more than $6 billion annually.
Ryan Lichtenwald is a writer and analyst for Lend Academy, the industry news leader that runs the largest P2P lending conference in the country. Below, he outlines what P2P lending is, what its benefits are and why every small business owner should consider it.
What is peer-to-peer lending?
Many people may have heard of Kickstarter and other crowdfunding concepts, and P2P lending is in the same vein, but with one major difference.
While crowdfunding services like Kickstarter don’t require repayment, P2P loans are very similar to that of a traditional bank loan, but instead of a bank lending you the money, investors do.
Instead of paying the bank back, borrowers make monthly payments to each investor through an intermediary, like Prosper or Lending Club, the two largest P2P lending services in the country. The benefits work for both sides. The borrower can often get a better rate than with a traditional bank, and the investors see better returns compared to other investing strategies.
“The way I look at P2P lending is it connects borrowers who need money with investors who have it,” Lichtenwald said. “In the past few years, CD rates are almost nothing, so institutional investors are very interested in this space, and the more investors there are, the more available credit there is in the market.”
How is it different from traditional lending?
It’s not as different as it might sound. Small business owners must apply for the loans like they normally would – providing credit history, bank statements, etc. – but rather than going through a bank, they’d work with an online lender, like Fundera, which specializes in small business P2P lending.
Once approved, the small business loan is given a rating by the lending company. This rating will affect the interest rate on the loan, and these can be as high as 26 percent for high-risk loans and as low as 6 percent for premium-rated opportunities. Once given a rating, it’s up to investors to put money toward that small business.
Generally speaking, investors buy “notes” of $25 each (i.e. four notes would be a $100 investment). Once the loan amount is reached, the small business gets access to the credit, and it must make monthly payments just as it would with a traditional loan.
“P2P lending is about applying technology to underwriting and expanding credit,” Lichtenwald said. “I think this is the way the industry is going because this is how the millennial generation wants to do business. They want to do everything online, and these companies provide that service.”
Why should my small business choose P2P loans?
P2P lenders have disrupted traditional lending practices much in the same way Uber disrupted taxi companies.
Through technology, P2P services run smoother and more efficiently than the traditional outlets, and this means the borrowing process is quicker, seamless and less intrusive.
And since P2P lenders have optimized efficiency, they can underwrite smaller amounts and still make a profit.
“Some traditional banks just aren’t willing to underwrite small businesses because they can’t do it profitably,” Lichtenwald said. “A lot of times these small businesses can have their P2P loan approved, and all the paperwork is done in a fraction of the time it takes a traditional bank. Some people are willing to pay more in an interest rate if they have a huge business opportunity such as buying a piece of equipment that can really send their business into a growth opportunity.”
Are small business owners more at risk when choosing P2P lending?
Right now the market is flooded with investors looking for better returns. One of the benefits of that atmosphere is more access to credit. In turn, there are more small businesses applying for P2P loans. That makes them very competitive, which means it’s rare to get approval without solid credit.
The inherent risk is not with the small business but rather with the investors, as there is nothing anchoring the loan, such as a house or the business itself. This means there isn’t as much incentive to keep up with payments as there might be with a traditional bank loan. Also, online lenders have to operate within the same regulations as traditional banks, so it’s not opaque and unregulated, which is another selling point for borrowers.
“I don’t think either party – lenders or borrowers – benefits more than the other in peer-to-peer lending,” Lichtenwald said.” The whole idea of P2P lending is lending-companies can operate with efficiency in the marketplace, but at the end of the day, if a small business borrower can get a better rate with a traditional bank, then they should go for it. It’s important to shop around.”
P2P lending is more than just a loan
One of the ways online lending companies are attempting to stand out from traditional lenders is by providing more services than just setting up the loan. Small business owners are always looking for value-added items that help them run smoother and more efficiently, and an industry based on efficiency is using its expertise to broaden its appeal.
“The other way these companies are differentiating themselves from traditional lending is they’re not just giving you a loan, but they’re also providing other valuable services to the small business,” Lichtenwald said. “You can be pre-approved for another loan based on solid repayment history. Once you’re in the system and show you’re a solid bet, these companies take a more proactive role with future lending opportunities, which means quicker access to more credit.”