With the evolution of crowdfunding and P2P lending, now has come the era of a different ecosystem for funding projects. The benefits of peer to peer lending for startups are not always on the surface since they usually go hand in hand with special pains. In this article, we will cover the advantages of p2p lending for startups and show why it can be good for your business.
P2P lending has already become quite mainstream, and over the past years, we have seen some tremendously successful campaigns that got funded fast in almost no time.
Before we jump into details of the pros and cons of peer-to-peer lending, let’s have a quick overview of what P2P lending is and how it differs from conventional crowdfunding.
What is P2P lending
P2P lending is a way to get money from a number of investors online. The lending process happens on a P2P lending marketplace where borrowers sign up and list their loan requirements and investors get a chance to look through all the available loan listings and decide what they want to invest into.
The loans are typically given for personal needs like house renovation, car buying, debt consolidation, or medical expenses. Such loans range from £500 to £35,000.
Small and medium-sized businesses (SMEs) can also count on getting a loan through a P2P lending platform. If a startup needs extra funding for asset purchase, research and development, stock purchase, expansion or acquisition, it can get a loan from £25,000 to up to £75,000 (sometimes even more).
Since the P2P lending industry is relatively new, pros and cons of investing in peer-to-peer lending for investors include less stability, the risk of losing money if the borrower fails to repay the debt, less liquidity, and no guarantee of profit (loans usually are unsecured).
How P2P lending is different from traditional crowdfunding
The fundamental concept here is that P2P lending is a special case of the crowdfunding model, and the main difference is the funding type.
Traditional crowdfunding works on equity-based investments – for example, equity stakes in real estate. P2P lending is a debt-based investment which presumes that the borrowers repay the loans in several instalments over a set period – usually 1 to 5 years.
To learn more about p2p lending and crowdfunding, read our blog.
The most popular P2P lending platforms are:
And now let’s move on to the peer-to-peer lending benefits and challenges!
Pros and cons of peer-to-peer (p2p) lending for startups
Let’s talk about all the good things crowdlending has for those companies which are at the starting point.
1. Streamlined application process (It’s easy)
What makes P2P lending win over a bank loan is a simplified application process. P2P lending platforms provide direct interaction between borrowers and lenders.
Borrowers sign up and describe the purpose of their loan in as many details as possible to make it more clear and attractive to lenders. They can also check the interest rates directly on the website and get an idea of how much they will need to repay.
The platform usually performs all the necessary checks quickly and makes your project available for investing in no time.
Peer to peer marketplaces usually ask for:
- Your personal information.
- The loan amount.
- Your credit score.
- What the loan is for.
- Your income range.
If you apply for a business loan for your startup, you may be asked to give details of your business financials as well as submit balance sheets, tax returns, and profit and loss statements.
Investors also take into account your time in business, revenue and profits, and revenue.
Lending Club provides a quote calculator (and requests quite some data) to give a clear understanding of the amount to be repaid.
Funding Circle has a similar signup process that allows getting your eligibility validated in seconds.
Same is with Kabbage – simple and clear.
Note: it doesn’t mean that whoever asks for a loan will get it. P2P lending platforms conduct thorough checks to determine credit-worthiness and will approve businesses with healthy financial track records. One of the disadvantages of peer-to-peer lending is the necessity of higher credit score (as opposed to other crowdfunding models). An online loan application is considered a soft inquiry and doesn’t directly impact the credit score, but P2P lending platforms pay attention to the number of credit inquiries in past six months.
2. Get funded quickly
The funding speed depends, but it’s highly possible to get your goal completed in 1-2 weeks. Unlike banks where the process can last for weeks on end, peer to peer loans is more transparent.
P2P platforms market their investment opportunity to a big crowd of investors. Since the investment amount can be as little as £10, the number of people who would like to participate is significant, and this is the key factor that helps P2P loans get funded at the drop of a hat.
Mintos platform displays vital information about the loan originator and answers many questions before they are asked. They also put an Invest button in a prominent way encouraging to invest right away.
Mintos also lists payment schedules on the investment opportunity listings which builds trust with those who are planning to invest their money.
Even if a loan is rejected by some platform, this becomes known quite quickly, and the borrower can try other platforms to get the funding through.
3. Better interest rates
There are a few ways to determine interest on peer to peer marketplaces.
– The borrower decides the interest rate they want, and the investor estimate whether they want to invest in such a loan. Of course, investors will be more driven by higher interest fees, but if the lender demand is high, the borrower can get funds even with a lower interest rate than they initially set.
– P2P marketplace sets the interest rate according to the requirements it specifies. In this case, credit grade, loan period and other parameters will affect the rate, which will be used for all borrowers with the matching requirements.
– Flexible rates to match demand and supply – the rates may move up or down depending on the recent demand and supply activity.
Again, if we compare with traditional ways to get funding, the interest rates in P2P lending are much lower. The interest is what makes the lender happy.
Just like with online shops, P2P websites don’t have buildings to maintain and administration costs to pay. Hence they can afford more attractive conditions than banks.
Usually, the platforms show the interest rates right away – Zopa gives this information when you decided to sign up for a loan:
Kabbage explains in detail how fees are calculated:
They provide a loan calculator as well and illustrate the payment schedule:
Also, borrowers who have already repaid their online loan have higher chances to get better interest rates when they decided to apply for a second loan.
Note: take into account that the P2P lending platform charges anything from 1% to 6% of the loan amount for application processing which is called an origination fee.
4. Quick access to funds
Money can be used immediately after investments start to come. Interest is only paid on the funds used, so the amount can sit there until it’s needed.
Besides, there is no obligation to take funds at all so if something has changed along the way there is no need to repay anything.
The platforms usually provide a convenient way to access funds through a mobile application or desktop. The borrower can choose the amount to be taken, review the repayment schedule, and get the money transferred to their bank account within 1-3 business days.
Repayments are also managed quickly and can be consolidated into one monthly payment, so there is no need to remember all payment schedules.
5. Unsecured loan – no collateral
This disadvantage of peer to peer lending for investors is an advantage for borrowers. Not all of the P2P lending platforms allow loans with no collateral and not all investors will agree to risk their money investing in such loans.
However, the platform requires a certain credit score and verifies eligibility by other parameters, and it might take collateral lightly and drop it from the requirements.
Cashflow is taken into account too, so if you have an established business, you may get away without any collateral.
Despite being a bailout for startups and small businesses, p2p lending presents some challenges for them.
Insufficient regulatory framework
Alternative lending is growing faster than the global legislation system can tear it down.
Most of the countries still don’t have enough regulatory basis for controlling relationships between the borrower and lender in the p2p sector.
Some governments monitor only specific areas while others strive to improve the current framework to adjust the needs of both parties.
It greatly influences the demand for p2p lending services as lots of businesses don’t find this fundraising method very reliable and turn to traditional loans.
The UK is the front-runner in the crowd. The FCA whose priority is to control peer-to-peer lending for startups has placed huge efforts to protect the rights of both parties.
In its recent report, the body suggests that platforms take more care of their clients by providing less risky services.
This is exactly what the young p2p lending market needs.
Lack of personal communication
Given that all interactions take place on crowdfunding websites, borrowers and lenders do not meet face-to-face.
On the one hand, it may not appear to be a big problem for companies. On the other hand, you never know who to shake hands with in gratitude for the support.
According to a survey, the lack of social interactions in the p2p lending process has a huge impact on the chances that a startup won’t be able to get a project fully funded.
In the past, some crowdfunding companies had social groups where clients could build personal communications.
Within these groups, potential borrowers could get advice on how to create a successful campaign, quickly raise funds, and even meet potential investors.
However, most of the communities are closed today and the issue of insufficient interactions still exists.
Another limitation of peer-to-peer lending for a business startup is small amounts of money that can be collected.
One of the original benefits of p2p lending was bypassing pitfalls small businesses encounter on their way to raise seed capital.
Unlike large corporations, small entrepreneurs have fewer chances to find a professional backer wanting to invest a couple of bucks. And banks simply don’t have a strong desire to collaborate with them.
On lending sites, handfuls of cash the crowd is eager to donate form relatively small credit pools that can be used to achieve unpretentious business goals.
Thus, if your idea is estimated at lots of money, then, probably, you should consider traditional loans.
Bad credit scores paired with high interests
The last but not the least. Crowdfunding companies take big risks when dealing with unconscientiously borrowers.
To protect backers, they set high return rates on non-performing loans in their portfolios.
The loan category is defined according to the credit-worthiness of a borrower. So, if you hope to get cash for very little interest, consider your credit rating first.
For those with an imperfect story, the price of raising funds may be too high and unbearable in the long run.
Note, that if you fail to repay a loan, it may dramatically impact your status as a borrower and reduce the chances of getting future loans.
P2P lending for startups is an excellent alternative to a traditional loan from a bank and is well suited for small businesses and startups.
Advantages and disadvantages of peer to peer lending are numerous and better be evaluated and weighed out before jumping into it.
Advantages include a quick online application, unsecured loans, fixed monthly payments, checking rates without affecting the credit score, lower interest rates, fast access and flexible use of money, no early payment fees.
Disadvantages are mainly focused on your eligibility. Interest rates may be higher if the credit score is below average, P2P marketplaces charge quite high origination fees against the loan amount (up to 6%), missed payments may have the negative impact on your credit score.
If you would like to build a P2P lending platform to serve small and medium-sized business just give us a shout – the niche is expanding, and we’ll be happy to help you get your share in it.