The recent financial crisis put access to capital in short supply for many small-business owners. As a result, alternative lending methods sprung up to fill in the lending gap created by traditional lenders’ reluctance to lend to all but the most creditworthy business borrowers.
One of these alternate sources of business capital is peer-to-peer lending. So how does it work, and is it a good source of credit for small-business owners?
Casting a Wide Net
Small-business owners seeking P2P loans register with a P2P lending website by submitting key financial information such as debt-to-income ratio, home-ownership status, existing debts, credit scores, and current income. Then, the website assigns a risk rating to the business, so potential lenders can decide whether the business falls within their personal lending criteria.
Many individual lenders are able to finance a single loan. Because the amounts pledged by individual lenders tend to be relatively small, the tolerance for financial risk is generally higher than that of a bank or other traditional lender. After all, each of these small-scale financiers may be pledging as little as $25, so there is little at stake.
Cheaper Capital, Better Returns
For small businesses with marginal credit, P2P lending offers a more affordable source of capital than a traditional business loan. The loans are unsecured, which means there is no need to use personal or business assets as collateral. In the event that they are able to pay off the loan before they have exhausted the terms, they may do so without prepayment penalties.
P2P lending arrangements also offer advantages to lenders. While the interest rates on these loans are lower than those charged by banks or credit card companies, they are typically considerably higher than what these lenders could expect to earn by leaving their money in savings accounts, or investing in savings bonds. On a larger scale, more affordable and accessible credit means a healthier small-business community, which has a positive effect on the economy.
Keep Your Options Open
While P2P Lending is a useful financial tool for small-business owners who might not otherwise have access to affordable capital, there are situations when this option is not an ideal solution. For example, P2P loans are generally only available in amounts of $35,000 or less, so larger capital needs cannot be addressed through this method of financing.
Savvy small-business owners know that the more financial options they have, the healthier their businesses will be. P2P lending is but one of many credit options, and while its requirements are comparatively lax, most other financial options have a higher bar for entry.
That’s why building business credit is a must. The financial flexibility that comes with a solid business credit rating means businesses will have access to the right financial products when they need them.