Over the last five years, peer to peer lending has become a popular alternative to traditional bank lending for individuals. However, just as mortgages and other traditional lending products have been used to finance small businesses and startups in the past, peer to peer lending can be an affordable source of funding for a new business. Let’s take a look at the advantages and disadvantages of this new financing option.
How does P2P work?
Peer to peer lending is essentially marketed as individuals and businesses borrowing capital from other individuals. In reality, this point of difference is typically overstated; peer to peer lending and bank lending are similar on one level as both products involve individual investors lending money to a borrower via an intermediary.
In exchange for potentially higher returns, investors in peer to peer lending typically have a higher risk tolerance than traditional bank depositors. This means that peer to peer lenders may be willing to extend credit more quickly or with less security than a bank. Peer to peer lenders typically have a lower cost profile (they’re typically an online only service), meaning that they can often offer borrowers competitive rates while continuing to offer reasonable returns.
Time is usually of the essence when a small business is attempting to fund a new project or purchase. Businesses generally aim to meet costs from operating revenue, so borrowed capital is usually for a large project or to take advantage of a fleeting opportunity rather than to cover operating expenses such as everyday manufacturing inventory. Peer to peer lenders usually market themselves as a quick line of credit, with most providers turning a loan application around in a matter of hours or days.
Access to Credit
One of the largest barriers for small business growth is access to credit, and peer to peer lenders have responded by offering much smaller loans than banks and other traditional lenders. Borrowers that are looking for less than $500,000 typically struggle with banks, whereas a peer to peer lender would usually be willing to extend credit for $50,000. This makes peer to peer suitable for an early stage startup that needs to buy an initial outlay of manufacturing inventory or minor plant and equipment.
Preserve Equity and Relationships
Because credit for small businesses can be hard to come by, many innovative businesses turn to equity investors for support. Although this can be the breath of life a new business needs, it often puts a steep price on success – if the business succeeds, the value of foregone shares can be significant. Ideally, equity funding would only be used to fund a significant expansion and not to fund short term expenses such as manufacturing inventory. Peer to peer lending allows small businesses to bridge a small financial gap without resorting to equity funding.
Crowdfunding for Small Businesses
Because both models are disruptive, small businesses often confuse peer to peer lending with crowdfunding. Crowdfunding is often used to secure small, bit-piece equity investors who collectively provide equity without taking undue control. It can be a useful alternative to debt funding, especially when a business is looking to expand and may struggle to service a high level of debt. For completely new ventures, reward-based crowdfunding may offer an novel alternative to borrowing a small amount of seed capital. Money raised through reward based crowdfunding is not required to be paid pack, although businesses provide unique rewards to backers. For example, a start up boutique snack producer might offer a hamper of its first products in exchange for a small financial contribution.
Small businesses struggle to get funding from banks and governments, especially in the UK. Peer to peer lending is unlocking access to funding for many small businesses that would otherwise struggle to grow. However, as with any financial decision, it pays to investigate every funding option before you sign with any funder whether equity or debt.