PEER TO PEER
LENDING FOR STARTUPS
If your startup or fledgling
enterprise requires additional working capital, a peer to peer (sometimes abbreviated as P2P)
business loan might provide a partial solution to your capital needs.
These loans, which are generally in the $10,000.00 to $35,000.00
range (although there are exceptions in certain cases and larger sums
may be available) are generally available for terms of between six
months and five years, and they vary widely with respect to costs, terms and loan
covenants. These sources are not constrained or subject to general banking regulations
While these loans are
universally priced higher than bank loans, today's bank loan approval
criteria make it extraordinarily difficult for a business with a
limited operating history (or any small business for that matter) to
obtain a loan. The loans available from banks and other traditional
lenders look to such security as second mortgages on the homes of
principals and also take into effect FICO credit rating scores –
and, as we know, very few entrepreneurs have sterling personal credit
reports.
Peer to peer loans may be a
means of paying for some of the initial startup costs associated with
commencing your operations, or as a bridge to the successful
conclusion of a crowdfunding.
Author and expert
Trevor
Dryer has written an excellent article on the state of peer to
peer lending as of the date of this writing. It is a must read for
all entrepreneurs.
###
Understanding
the Risks and Rewards of Peer-to-Peer Lending
By Trevor Dryer
If you run a small business, you probably know all too well the
challenges of trying to get a loan. It can take days to research
options and fill out inches-thick paper applications, only to wait
weeks, and even months, to find out you were turned down. All the
while cash flow is tight, and you’re struggling to hire new
employees, manage inventory, buy new equipment, or open a new
location.
As you may have experienced, getting a business loan has gotten
more problematic during the last several years. The economic downturn
in 2008 created significant obstacles for banks and other traditional
“Main Street” financial institutions that traditionally lend
to small businesses.
State of Small Business Lending
For example, many banks are increasing their capital reserves to
comply with new standards initiated by bank examiners and other
regulators, which can undermine a banks’ ability to underwrite
small business loans. In addition, compared to large businesses,
small businesses are riskier lending propositions because they are
more sensitive to swings in the economy, have higher failure rates,
and fewer assets to use as collateral.
Small business loans also are not as profitable for banks, because
they cost the same amount to originate as larger loans. For this
reason, banks tend to put less emphasis on lending in the
sub-$500,000 range. This creates a large lending gap for small
businesses, which tend to seek out significantly smaller loans;
70 percent of small businesses seek loans of less than $250,000,
with more than half of those needing loans of $50,000 or less,
according to the Federal Reserve’s “Small Business Credit
Survey.”
Realizing an opportunity to reach an underserved market and
building on the trend of crowdfunding, new types of small business
lenders have emerged. Funded by Wall Street investors, these online
and peer-to-peer lenders–such as OnDeck and Lending Club–are
leveraging technology and user-friendly Web-based application
processes to quickly respond to loan requests from small businesses.
By reducing the origination costs, these processes make it more
profitable to lend smaller amounts.
Rewards of Peer-to-Peer Lending
Online lenders are exploding in popularity, thanks to their
customer-friendly practices and ability to give small businesses fast
access to much-needed capital. Industry experts estimate that since
2007 online lenders have originated an estimated $10 billion worth of
small business loans, with the majority of the lending taking place
in the last few years.
Despite the buzz around online lenders, they still only account
for less than 1 percent of total small business loan volume. In
comparison, new small business loans originated by banks alone
account for roughly $200 billion annually, according to the FDIC.
While traditional lenders still originate the lion’s share of
small business loans, there are certainly times when working with
online lenders may make sense for your business. For example, if your
business needs cash right away or requires flexible payment terms,
such as paying a percentage of your credit card receivables instead
of a fixed monthly payment.
If you’ve just started a business, getting a loan from an online
lender also may be an option to help you start establishing a
credit history. Or, if your business has a less-than-stellar credit
or financial situation, it could help you repair your rating to help
you qualify for a loan from a traditional lender in the future.
Risks of Peer-to-Peer Lending
As with any decision related to your business, when seeking loans
from online lenders, it is important to weigh the risks versus the
rewards. Behind the slick user interface, excellent marketing
tactics, and fast approval turnaround, there are some potential
pitfalls that could negatively impact the bottom line for many small
businesses.
It’s important to consider several factors when choosing an
online or peer-to-peer lender to ensure you don’t get caught
off-guard by unpleasant surprises, such as:
●
Restrictive or shorter repayment periods. Some
online lenders require payment in just six months, which is
considerably shorter than the three year intermediate-term loans that
banks offer. This would result in monthly payments higher than if you
had a longer repayment period.
●
Exorbitant interest rates. Many small
businesses are used to comparing the cost of loans by using the
annual percentage rate (APR), which is the periodic interest rate
multiplied by the number of compounding periods in a year, and
includes certain non-interest charges and fees. But doing the
same when deciding whether to use online lenders becomes problematic
because repayment periods are often less than a year, there may be
terms that require larger payments in the first few months of the
loan, or there are hidden fees not incorporated into the advertised
interest rate.
Some online lenders may not even technically be offering loans per
se. If you look closely at their contracts, their offers may be
structured like a cash advance, which is similar to the tactics used
by payday lenders to avoid having to comply with lending regulations.
By accepting a “cash advance” instead of a loan, your rights
could be greatly limited when compared to a traditional bank loan
that offers protections through federal and state lending laws.
Because of these variations, you often end up paying significantly
more for a loan from an online lender.
A comparison of online lenders by
Fit
Small Business estimates that average APRs range from 40 percent
to 80 percent. Once the various fees are factored in, borrowing from
other online lenders could potentially result in estimated APRs as
high as 300 percent. Banks and credit unions, on the other hand,
typically offer an APR of 6 percent to 8 percent.
●
Surprise fees. While banks often include
their in the calculation of APR, online lenders can have a number of
fees of which you may not initially be aware. You will want to check
the fine print closely to understand the types of fees for which
you’ll be responsible, including those for origination, daily loan
guaranty, and prepayment.
●
Lack of a personal relationship. Banks
typically forge long-term, personal relationships with their account
holders and understand the nuances of the small businesses and the
local markets they serve. If you primarily use one bank for all of
your accounts, this relationship can translate into lower fees and
ancillary perks, such as higher rates on savings accounts or waived
annual fees on accounts or credit cards.
These long-term, personal relationships can become more valuable
as your business grows, because your bank can provide new financial
products or structure financing differently to correspond with your
company’s stage of growth. Many banks indicate they would prefer to
loan to their existing clients, but cannot if these small business
customers don’t meet their lending criteria.
Online lenders do not have the ability to develop these types of
personal, face-to-face relationships with small businesses.
●
Who is funding your loan? The source of
funding for loans also can play a role. Banks rely on FDIC-insured
deposits, which helps keep the cost of capital low. Online lenders
have high-cost capital from institutional investors and other sources
that are looking for high yields, and this capital is at considerable
risk if Wall Street loses interest in funding this type of business
model or decides to move their capital elsewhere.
New Standard for Borrowers
Online lenders have truly set a new standard for borrowers.
They’re improving the user experience with simplified online loan
applications and, in some cases, almost instantaneous lending
decisions. They’re also expanding into a diverse range of loan
options for general consumers, students, and small businesses.
Banks and credit unions are quickly learning from the competitive
pressure and success of online lenders. Some of the most
forward-thinking lenders are now adopting technologies that will
mirror the online lending experience and offer the low interest rates
that only banks and credit unions can provide.
These technologies enable loan officers to make faster decisions
while reducing origination costs for even small dollar loans, which
in turn will increase the number of small business loans banks and
credit unions can make and meet the needs of businesses that are
seeking smaller loans.
About the Author
Post by: Trevor Dryer
Trevor Dryer is the CEO and co-founder of Mirador Financial Inc.,
a small business lending platform for banks and credit unions. He
has dedicated his career to creating financial technologies that
create opportunities for both financial institutions and their small
business customers. Prior to Mirador, Trevor launched new financial
and payment products at Intuit for the company’s small business
and banking divisions. Trevor earned a Bachelor of Arts degree from
Harvard University and a Juris Doctor from Stanford Law School.
###
Some peer to peer lending match up platforms (for information purposes only, as neither the
author nor
GEI
Consulting endorse or vouch for the quality, integrity or pricing
of any of these services) are listed below for your investigation.
You must investigate each of these platforms thoroughly before
proceeding with the loan application process, and be certain you
understand fully all of the terms offered to you. These loans can be
very expensive in many cases, but they may well be cheaper than
either the cost of undercapitalization or the cost of inviting a stranger in as an
equity participant:
Lending Club
Prosper Marketplace
Funding Circle
Upstart
Kiva
Zopa
OnDeck
Labels, Tags, Keywords, Categories And Search Terms For This Article:
business, startup, peer to peer lending, P2P, crowdfunding, loans, capital sources, private loans, loans via internet, GEI Consulting, Douglas E. Castle, entrepreneur, alternative financing.
Good luck in your search for
capital, and thank you, as always, for reading me.
***************
This site is sponsored by Global Edge International Consulting Associates, Inc. ["GEI”]
Click HERE To Contact GEI, or telephone us at 1.212.299.5182.
Free Subscription to The GEI Business Daily!
Sign Up For Our Free GEI Newsletter!
Receive Our Free GEI RSS Feed!
Free PDF Download: GEI Complete Services Summary.
Free PDF Download: GEI Financing Services Outline.
***Follow GEI's Company Page On LinkedIn!
[Return To GEI Website]
Please Like GEI on Facebook...
Please Follow GEI on LinkedIn...
Please Follow GEI on Twitter...
