Traditional business loans have typically come from either big banks or smaller, local banks and credit unions. But the process is slow, rigorous, and strict, frustrating many business owners who want to expand their business. For others, an outright rejection of the loan prevents them from getting started in the first place.
Luckily, alternatives have started to emerge. Peer-to-peer (P2P) lending has exploded in recent years by providing more flexible lending options for businesses. The industry is projected to reach $150 billion or more by 2025.
The P2P model eliminates many of the regulations and protocols that have traditionally come attached to loans. In many cases, lenders have the opportunity for a greater return on investment, while borrowers have more flexibility and lower interest rates. And the most appealing part of it all is that all transactions are conducted online, saving all parties involved a lot of time and stress.
So let’s take a look at some of the most popular P2P lending sites as well as a few of the pros and cons of peer-to-peer online lending.
Peer-to-peer lending, as the name suggests, is financed by individuals rather than by a financial institution. It might also be referred to as crowdlending or social lending.
P2P online platforms simply connect borrowers with investors. Investors can open an account on the site and deposit a certain amount (there are usually minimum initial investments). Some sites guarantee flat, fixed returns, meaning that the lending platform is on the hook to cover defaults, rather than the individual investors. The rate of return for these investments, of course, are much lower and more akin to savings accounts. Others offer greater returns, but a sour loan leaves the investor out the money.
Additionally, investors and borrowers have the choice of automating everything through settings and algorithms or manually agreeing to loans and their terms. In either case, the specific terms of a loan can vary widely. The loan amounts range from $1,000-500,000, interest rates from 5-40%, and terms from 3 months to several years.
For the services of facilitating the transaction and assuming risk, the peer-to-peer lending platforms will take some sort of fee. Most of them collect the entire origination fee, which is always a percentage of the loan amount. Some will also take a small percentage of the interest payments. Not financial institutions themselves, each lending website will partner with one or several banks to send the loan and receive payments.
The Pros and Cons of P2P Lending
Peer-to-peer lending is another exciting development, made possible by a public frustrated by an antiquated system and the powers of the internet. Originally only popular with a small, non-conformist niche audience, P2P platforms have exploded in popularity over the past five years. Amazingly, nearly 5% of Americans have received a loan through a peer lending site.
The lenders cover a variety of types of loans, both personal and business. While this article is only referring to the business side of operations, the personal loan side is equally intriguing.
Critics of the system warn that the default rates on P2P loans are alarmingly high, resembling the trends that led to the subprime mortgage crisis and financial collapse of 2008. While the broad economic fallout from collapse to the system would be far less, it would nonetheless be devastating for those with a stake in the game.
The risk assumed by investors can also be dangerous. Default rates on P2P loans are much higher than other borrowing institutions.
Finally, borrowers must also beware. Like anything financial, the fine print matters. A certain fee, penalty, or rate can have profound financial impacts and mean that a great-sounding deal is actually a terrible business decision. Make sure you do your homework or consult someone who does before signing anything.
Take a look at the brief overviews and reviews of several of the most popular lending sites and see which might be a good fit for your business.
LendingClub was founded in 2006 and quickly rose to be one of the biggest players in the P2P lending field. They’ve issued over $45 billion in loans to over 3 million customers in their brief existence and control nearly half of the entire market.
LendingClub also offers a variety of different loans. Business loans start at $15,000 and go up to $300,000, but they also provide personal loans for debt consolidation, credit cards, and home improvement projects. Business loans have a fixed interest rate and are 6-month to 5-year terms with no penalty for early payment and have origination fees ranging from 3.49% to 7.99% (these are one-time upfront fees that are deducted from the loan prior to the borrower receiving it). LendingClub strongly favors lending to existing businesses and is unlikely to issue a loan to a new business.
Started by former Google employees, Upstart differentiates itself by putting less importance on credit score. They’ve also introduced new acceptance/rejection factors like education and work history. Despite this, Upstart boasts the lowest default rate in the P2P lending industry at just 6%.
Their loans range from $1,000 to $50,000 and come in 3-year or 5-year terms. There is no requirement for paying the loan early. Interest rates vary between 7.69% and 35.99% depending on the borrower’s FICO score and additional factors. Upstart is popular among young professionals and business owners. Most business loan borrowers have a college degree and are seeking money for business start-ups. Applying for a loan is remarkably easy and painless.
3. Funding Circle
Funding Circle focuses exclusively on small businesses. The founders decided to start Funding Circle after their loan application for a separate business was rejected nearly 100 times. The lending platform has helped finance over 65,000 businesses across the world, backed by a diverse array of investors.
Loans begin at $25,000 and go up to $500,000 for 6-month up to 5-year terms. The loans can be used for expanding a business, investing in equipment, hiring more employees, renovation, or even marketing, though few loans are granted to new businesses. Origination fees are typically 4.99% and annual percentage rates (APRs) range from 5.49% to 20.99%.
Kiva is another lending site focusing on SMBs while also providing assistance to farmers, students, builders, and other borrowers who may be underserved or are financially excluded in their communities. Kiva was founded in 2005 in San Francisco and is an international nonprofit. They crowdfund loans so people can lend as little as $25 with 100% of the funds going to borrowers.
They are a unique option for small business borrowers because business owners have the option to take out loans from Kiva’s Field Partners, which consist of organizations with the same social mission who will not charge unreasonable interest rates.
Another option is taking out direct loans which most often borrowers are able to have 0% interest rates on. The individual lenders are usually donating the funds or loaning the money to support SMBs and causes they care about, as opposed to loaning money for the purpose of growing it by collecting interest rates.
For businesses owned by veterans, StreetShares is the way to go. The lender offers loans up to $100,000 with 3-month to 3-year terms and don’t charge early payment fees. They typically require business to have been in operation for at least a year with a proven revenue stream of at least $25,000/year and a personal credit score of at least 650. Loans come with added flexibility, customizing repayment terms based on the borrower’s financial ability.
While StreetShares marketing might be a bit cheesy, they provide fast and reliable loans and lines of credit. It pays to have a good credit score – high scores can mean single digit loan APRs (they can go as high as 39.99%). Origination fees are also low, at only 3.95-4.95%. Finally, they take your business model and goals into account. A passionate pitch can catch the interest of multiple investors, securing your loan.
Another fast loan option for small businesses, OnDeck offers term loans up to $500,000 and lines of credit up to $100,000. Origination fees range from 0-5%, terms range from 3 months to 3 years, and APRs start at 9.99%.
Like many of the other P2P lenders, OnDeck requires applicants to have been in business for at least one year and $100,000 in annual revenue. All borrowers must have a personal FICO score of 600.
OnDeck usually provides applicants with an approval or rejection within several hours and has the cash deposited within 48 hours, making the process remarkably fast. They also reward long-term borrowers: fees and rates decrease with each subsequent loan. Their initial rates are higher than average, however. They also do not void prepayment fees. Every borrower is on the hook to pay at least 75% of the original interest fees, even if they pay off the loan the day after receiving it.
Unlike the others on this list, Fundation is a direct lender. Most other online lending options serve as intermediaries that facilitate and insure a loan using capital from a partnering bank. This makes them similar to traditional lenders, therefore coming attached with more traditional loan requirements and restrictions.
Business applicants must have been in existence for at least 2 years with over $200,000 of annual revenue. They also require personal credit scores to be at least 620 for loans less than $75,000 and 640 for greater amounts. Loans can go as high as $500,000 and terms as long as 4 years. For safer loans, the APR can drop in the single digits.
While faster at processing loans applications than traditional banks, Fundation requires a lot of upfront information to begin the process. Loan approval after submission takes 1-3 days.
Are There Other Alternatives?
There are! One alternative is looking at the U.S. SBA loans. They have developed several programs in connection with multiple lenders to help fund small businesses. They have guaranteed options with rates and fees similar to non-guaranteed loans with benefits such as lower down payments and flexible overhead requirements. Some loans even require no collateral.
One of their known traditional programs is called the 7(a) program deployed by SBA lending partners and is an all-inclusive loan program that offers loans up to $5 million to SMBs. Business owners can use the proceeds for working capital, expansion/renovation, inventory, equipment, refinancing debt, seasonal line of credit, or starting a business.
For a list of other financial assistance available for small businesses, check out our other blog here.
A Second Funding Alternative
Another alternative involves merchant services. Some credit card processing companies work with businesses and banks in a similar role that lending platforms operate. Collateral will lower interest rates for any loan. In this case, the collateral is a business’s revenue. Businesses with proven revenue may be able to secure a loan by making payments directly through this revenue. Merchant services can skim a percentage off of every sale to send directly to the bank as payment for a loan. This better guarantees the lender against default, allowing for more favorable terms of the loan.
If you’re a KORONA customer, let us know if you’d like more information on this. We work with many payment processors and can help you navigate this type of loan. If you’re not already a KORONA customer, let us know if you might benefit from a new POS system. Check out the link below to find out more about how KORONA can improve your business. Sign up for a free trial so you can see the software firsthand!
Among other things, Michael writes about trends and tips in retail for KORONA POS. His focus is on bringing small business owners a more holistic approach to growth. In his spare time, you'll find him hiking somewhere in the southwest. Connect with him on LinkedIn.