Peer-to-peer (P2P) lending has been gaining popularity as an alternate source of financing for individuals. However, peer-to-peer lending can also be used to finance small businesses and start-ups. This article outlines the basics of P2P lending – its advantages and disadvantages – and discusses better financing options.
What is peer-to-peer lending?
Peer-to-peer lending is a type of financing by which an individual can get a loan from other individuals through a P2P platform. Basically, peer-to-peer facilitators like Prosper and Lending Club work with people who need money and other people (called “investors”) who lend money. They facilitate the process of getting these two parties together. Individual investors don’t lend the full amount of the loan. Instead, most investors invest small sums of money on a number of loans in order to mitigate their risk.
Loans are often limited to about $35,000. The lending process varies by site. Basically, once you submit an application, the site lists your loan request. This listing allows investors to start placing funds. Listings have a deadline, and if the loan request is not funded by the deadline, you have the option to take a partial funding or decline the loan.
Most peer-to-peer lending solutions do not lend money to businesses. Instead, they lend money to the individual, who then uses the money for their businesses. People seeking loans must provide information about themselves, their finances, and how they intend to use the money. Most P2P companies request your credit information for credit-scoring purposes.
Advantages of P2P lending
The most important advantage of P2P lending is that it can provide financing to entrepreneurs who need less than $35,000 of funding. P2P lending offers a viable alternative for entrepreneurs who cannot qualify for bank financing. Note that most lending institutions don’t work with companies that need small business loans because these loans are not very profitable.
Another advantage is that many P2P loans have affordable interest rates, especially when compared to alternatives. Lastly, most P2P loans are unsecured and don’t tie up any collateral directly (e.g., via a UCC lien). This benefit is important for small business owners who may need financing later on.
Challenges of P2P lending
One important thing to keep in mind is that peer-to-peer lending companies often use your credit score to make decisions. Because prospective investors have access to this credit information, P2P lending may not work for you if you have bad credit.
According to most P2P sites, “most” loans get funded within 7 to 14 days. This time frame sounds quite good and is faster than that of most banks. However, there is a chance that your loan won’t be fully funded – or funded at all. It’s all up to the investors.
While P2P lending may help you set up a very small business, it may not be much help if your business grows. Most growing companies need more than the $35,000 limit. If you grow, you need to seek other options.
Lastly, loans have a closing fee. The fee averages 5% of the loan at the time of this writing. This cost can be steep. By the way, the fee is usually deducted from the loan itself. Therefore, adjust your loan request to account for this cost.
Are there better options?
Using a P2P lending network can be a good way to finance your business if you have good credit and if you need less than $35,000. However, there are three additional options to consider:
- The Small Business Administration (SBA) – The SBA is often overlooked by small business owners. However, the SBA has a very attractive Microloan program that provides up to $35,000 of financing to small business owners. This loan is a true small business loan. Furthermore, these loans are designed specifically to help small business owners and are easier to get than conventional loans. Individuals who don’t have good credit can still apply. Microloans are often offered by lending institutions that partner with the SBA’s goal of fostering small business. Through this partnership, the SBA provides training and counseling to small business owners – a valuable service for entrepreneurs.
- Small Business Factoring – Another option for small companies that need financing is small business factoring. Factoring helps small businesses that sell goods or services to other companies and have to wait up to 60 days to get paid. Often, small businesses have to offer credit terms even though they can’t afford to. They end up running out of money while waiting for payment. Factoring improves your cash flow by providing an advance on your slow-paying invoices. Transactions settle once your customer pays on their regular schedule.
- Purchase order funding – One alternative that can help finance small businesses that resell products is small business purchase order funding. This program helps companies that buy products from vendors and resell them to corporate or government clients. Purchase order funding provides financing to pay suppliers, which allows you to deliver the order and book the revenues.
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