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What Small Business Needs to Know About P2P Lending

What Small Business Needs to Know About P2P Lending

We all know and love Uber, but what happens when Uber’s business model is applied to lending money? Peer-to-peer (P2P) lending is connecting borrowers to lenders in the same way that Uber connects passengers to drivers. But how does it all work, and is it a good option for small business owners?What is P2P lending?P2P is the large scale lending of money between people/businesses and everyday investors online. It’s like borrowing money from a friend, with an online intermediary that provides security to both parties. Interest rates are kept low due to the efficiencies of operating online. The biggest differences between P2P and traditional loans are that the P2P loans are funded by everyday investors, and they specifically appeal to a younger audience. Startup companies and young loan seekers are likely already familiar and comfortable with the ideas of crowd funding, which are related to this model of loan.How does it work?Potential borrowers agree to a credit check and to disclose their debt-to-income ratio. Platforms approve the highest quality borrowers and assign them something similar to a credit risk score. Borrowers are assigned an APR befitting the credit risk they pose to lenders.There is a high potential for default on P2P loans as they are unsecured and administered virtually. There’s no collateral holding lenders to pay, and there is no face-to-face contact with the borrower. Diversification allows lenders to combat this high risk. Lenders invest in portions of many loans so they only lose a fraction of their investment if a borrower defaults. This typically results in a net return of 7-8% of the original investment for the lender.Who are the key players in P2P lending?Lending Club. Serendipitously founded in 2007, before the financial crisis of 2008, Lending Club was one of the first players in the P2P field. With low interest rates and willingness to take risks on people with little credit, Lending Club came out of the gate strong and they are still the largest in the P2P field, loaning over $1 billion from January to June 2014. In recent years, Lending Club has become more traditional in that they have been collaborating with banks that are buying loans and repackaging them for their own use. In August of 2014, Lending Club announced its intention to go public and is looking to raise $500 million dollars in capital. It is expected to be one of the hottest tech IPOs in recent history.Upstart. Upstart was founded in 2012 and specifically targets borrowers with little credit history. Upstart’s team considers both education and employment history in their loan applications to determine which borrowers to support. They advertise themselves as the “super chill” way to get a loan. The average Upstart loan size is smaller, between $14–15k. The company is proud of the fact that the average debt-to-income ratio of their borrowers is significantly lower than Lending Club.While Upstart appeals to younger audiences, but Lending Club has more clout in the industry.Pros and Cons of P2P loans for Small BusinessesProsBanks are often hesitant to lend money to startups or small businesses, but P2P lending is a low impact way around banks.Low interest rates that range from 5.9% for businesses with stand-out creditMost P2P loans are term-based. Many businesses enjoy the idea that in 3-5 years they will be debt free. According to Peter Renton, founder of LendAcademy.com, that “forced discipline” that comes with monthly payments is appealing to borrowers.ConsP2P loans are not legal everywhere. Some states allow P2P borrowing, but not investing. With such a new field, the Securities and Exchange Commission (SEC) is learning how to enforce regulations. Here’s a map of where Lending Club is available.Hidden fees are attached to many P2P loans. These origination fees are typically 1-5% of the total loan amount that is included in APR and subtracted from the total loan amount.P2P loans can require a lot of financial savvy and time that small businesses are not equipped to handle. Although you get the flexibility of not having to go to a bank to get your loan, it also requires you to do a lot of work on your own.Because of the newness of the field, there’s a lot happening in terms of mergers, acquisitions, and jockeying in the industry that could create risk for borrowers.Regardless of all of the pros and cons, P2P lending is here to stay, and it will likely continue to evolve with new technology, information, and regulations that will affect small businesses seeking loans. If you partake in a P2P loan, we recommend asking your accountant to help you manage the legal or business changes that might affect your loan. Remember, there are many, many ways to utilize your accountant!

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