Business Financing Through Peer-to-Peer Lending Sites

The current business environment is characterized by a tight credit market, more stringent underwriting standards, and a reduction in available debt capital, which is making it very difficult for small businesses to get business loans. In order to finance ongoing operations and business expansion, business owners have to find new innovative ways to raise capital. One of these new creative financing methods is supplied by peer to peer lending web sites. Peer to peer (P2P) lending gives investors a way to pool their money to make business loans, while providing business owners with an alternative to traditional bank financing.

Of these peer to peer lending sites, the major players include Zopa, LendingClub, Prosper.com, and Loanio. The deals that these sites have made can be substantial in a number of loans and the amounts borrowed. One of the largest of these sites, Prosper.com, has made over $185 million of fixed rate individual and business loans of up to a maximum of $25,000, since it launched back in 2006. Other than the source of the capital, the process in which loans are approved is similar to any other traditional lending institution. A borrower registers at one of the lending sites who then underwrites the borrower’s ability to repay by traditional methods including running the borrower’s business credit report. Once the analysis is complete, the borrower is assigned a credit rating, which gives an indication of how likely it is that the borrower will service the loan.

As part of the approval process, the borrower completes a loan listing indicating the amount requested, (and if a business loan, the details of the business) an explanation of the financing needs, and the borrower’s ability to repay the loan. In order to underwrite the business, the borrowers must provide financial statements detailing income and expenses as well as a forecast of future cash flows including principal and interest costs. Borrowers must indicate the highest interest rate that they are willing and able to pay, and any applicable loan costs that have been agreed to. Peer to peer lending rates are set at the discretion of the lender although they must abide by usury and any other state lending regulations.

Businesses that have previously established a business credit profile usually have a better chance of approval than those without one. A business credit file not only provides the lender with the payment histories between the borrower and other creditors and vendors but also provides explanations about how and why the borrower may be a better credit risk than their credit rating might otherwise imply.

Business with relatively low credit ratings can still be approved for a peer to peer loan, although they will probably have to pay a higher interest rate than those with better business credit. Since the loans are not securitized and are held by the investing pool, peer to peer lending sites can provide both conventional and higher risk loans. Once your loan profile is posted, investors will bid on the loan until it is eventually funded. Since investors in a pool can contribute as little as $100, many individuals must decide to participate before the loan can be made. As part of the approval process, investors may ask specific questions about you and your business that need to be addressed directly and immediately.

As they bid, lenders note the lowest rate that they will accept for participating in the loan. At the end of the bidding period, the peer to peer lending site company evaluates the investor proposals and then determines the interest rate you will have to pay. If time runs out before the requisite number of investors decide to participate in the loan, then the loan request is cancelled and must be reposted again if the borrower wants to attempt getting approval for a second time.

If the loan is eventually approved, then the peer to peer lending site will administer the loan and collect the loan payments. Like traditional loans, making prompt debt service payments will strengthen your business credit and make it easier for you to receive funding in the future. On the flip side, if you fail to make scheduled payments or make payments late, your business credit will be negatively affected and will make it harder for you to get financing and decent trade terms from vendors. If things get really bad, your account will be passed to a collections agency, the collections effort will be posted to your business credit file, and your credit rating will be reduced accordingly.

Although peer to peer lending sites are providing business owners with an innovative way to borrow and an alternative to bank financing, many of the the same rules apply. Companies will still need to establish and maintain good business credit well in advance of the need for funds. Since it is getting more difficult to obtain external financing, the value of good business credit is also increasing. Regardless of the source of capital, whether it is a traditional bank loan or line of credit or a new variation such as the peer to peer lending site, companies will still need to manage their business credit if they expect to be financed.  Although the funds are coming from different places and are funded by a different type of investor, lenders still need to be assured of a borrower’s credit quality before they will part with their capital.