Peer-to-Peer Lending Sites: A New Bank for Small Businesses?

by Vanessa Richardson on April 26, 2011
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Now that credit is tight and banks are reluctant to take chances on small-business loans, more entrepreneurs are trying a new way to obtain the cash they need: from their peers.

Websites like Lending Club and Prosper connect people needing cash for personal or business reasons with willing lenders looking to profit from the interest rates. For business owners, the allure of peer-to-peer lending is easy to understand: You’re able to get an unsecured loan (up to $35,000) quicker, cheaper, and more easily than through a traditional lender.

Chris Dagger is a believer. As CEO of Custom Confections, a bakery headquartered in Warren, Mass., he needed to finance the opening of a second shop. But having newly arrived in the U.S. from England, he didn’t have a business track record or credit history. When Dagger made the rounds of banks, some refused him financing while others wanted to charge exorbitant rates. But having been a “lender” through Zopa, a British peer-to-peer lending site, and profiting nicely from it, Dagger decided to try it as a borrower.

“It seems to work like any other finance option,” says Dagger. “They [the lending site] look into your finances, whether you are affordable in terms of what you can pay back, then they pre-approve you for a certain amount. Then I go to the website to put up my pitch, and people decide whether to invest or not.”

Dagger chose Lending Club, and got a three-year loan for $8,000 at 20 percent interest, which makes monthly payments $330. Financing came quick, he says. “I put the pitch up on the website last November, and was fully funded in 10 days. And the money was sent  into my account very quickly after that.” Dagger opened his second shop in December, and now has a licensing agreement with a bakery in Los Angeles.

Wait: 20 percent interest? Yes, it’s very high. That’s because peer-to-peer lending sites are where many borrowers go after being refused by traditional lenders, and these websites know it, which is why they often charge more in interest. However, LendingClub and Prosper say their rates range from 8 percent to 21 percent, mainly depending on your credit score. Those with lower credit scores and less credit history, like Dagger, will be charged more in interest.

And that’s another thing to consider when taking a P2P loan: These are not classified as business loans, but as personal loans you’re going to use for business. The lending sites issues loans based solely on your individual credit record, so by adding a new loan –  especially a big one in the five figures — to your consumer debt load, your personal credit score may go down. In other words: As with any form of financing, make sure you can pay back the loan before you take one out.

Dagger says when it comes to raising finances, he wouldn’t do anything but peer-to-peer. “The bank is the last place I’d go. This is a much easier process.”

Here’s advice Dagger would give for other small-business owners considering peer-to-peer lending sites for their next loan:

  • Be honest about your situation. “These are real people putting their faith in your business. And they’re smart — they can see if you’re trying to screw them.
  • Take your time and do your research on these sites. “Make sure you’ve got plenty of time before needing the financing so you can shop around. I may have been able to get a better deal if I had more time before I needed my loan.”
  • Put details and numbers in your pitch. “Investors like to see numbers in order to determine whether you’re affordable and are thinking long term. Remember that there are two types of peer-to-peer lenders: the general public who like the general concept, and serious lenders. The latter is a smaller group, but they lend the big money. I had one lender alone contribute a $500 block to finance our loan, which is a big risk. I think by having good numbers in my pitch (I broke down what we needed item by item, where we were sourcing from, and I provided proof of affordability), I attracted the wealthier investors and reached the loan amount quicker.”
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