A Quick Guide to P2P Lending
By Ryan Ayers
Funding is one of the most important aspects of getting a business going. Every entrepreneur and business owner knows that you don't have a business without the money to run it! It's tough to get funded, and many entrepreneurs have to get very creative in patching together enough cash to make ends meet. Luckily, our digital world has made it easier than ever for business owners to connect with investors in lots of different ways. Peer-to-Peer (P2P) lending has recently had an enormous impact on the creation and growth of new businesses, prompting many business owners to wonder whether it's a good option for them. If you've been curious about what P2P lending is, and whether or not it's right for you, here's a quick guide to the basics.
What is P2P Lending?
P2P lending is type of financing that involves borrowers and lenders interacting without the use of a traditional bank or other financial institution. While this has many advantages, including higher interest rates for lenders and fewer requirements for borrowers, it can sometimes be a risky way to finance a new business, since the process is not backed by a financial institution. P2P lending takes place through an online platform, which uses big data to match lenders with borrowers (usually pooling money from multiple investors together), and sets default and interest rates. These platforms also take a small percentage of the interest owed to lenders in order to make money themselves.
How is P2P Lending Different?
P2P lending is a form of social lending, since it involves peers loaning and borrowing money from one another, without a middleman. In traditional lending, borrowers often have to meet rigorous financial requirements to be approved for a loan. In P2P loans, however, a financial institution is not involved, and investors are granting loans directly to borrowers, allowing borrowers to bypass the bank system and be approved for a loan they might not get otherwise. Of course, once a deal has been reached, the money is transferred to the borrower's bank account-but the bank is not involved in the loan transaction itself.
What are the Benefits?
Securing funding has always been a challenge for entrepreneurs. Venture capitalists give out huge sums of money to a select few promising startups, while family money, traditional bank loans, and crowdfunding have all been instrumental in getting other businesses off the ground. P2P lending is a good alternative to these options because it can be much easier to secure needed funding without hoping for a miracle angel investor or having 100% perfect credit.
P2P lending is quick, and though the interest rates are attractive to lenders and offer higher returns, they're often lower for borrowers than traditional loans from financial institutions. Most P2P platforms are simple and easy to navigate, and can help lenders make money in more stable marketplace than the stock market.
Startups can benefit from P2P lending for all of these reasons. 82% of startups find the fundraising environment challenging, and with venture capital dropping 11.3% in a year, as of the first quarter of 2016, other options like P2P and crowdfunding are becoming necessary for companies that want to grow fast.
What are the Challenges of P2P Lending?
No system is perfect, and like any form of lending, P2P is not without its challenges. Many people are worried about the regulation of the P2P system, since it is fairly new, and laws have not come into effect to control the industry. Additionally, many Americans are worried about financial cyber security with all-online platforms, since data breaches are a frequent occurrence around the globe. Some of the biggest challenges, however, are on a smaller scale. Though P2P lending platforms don't have the same requirements for borrowers that banks do, credit score can be an issue for some borrowers. It's currently not possible to use a business credit score, meaning that poor personal credit could affect potential borrowers' ability to get a loan at a decent interest rate.
P2P Lending in Action
The P2P industry is growing-and fast. The first platform for this service, Zopa, was launched in 2005, with others soon to follow. In 2014, P2P platforms in the US gave out around $5.5 billion in loans-a figure that has been dwarfed in just a few short years. US-based Prosper has funded over $6 billion in loans on its own, without taking into consideration other players in the field. By 2025, the industry is expected to reach at least $150 billion.
Millennials are leading the way in P2P lending-they're almost 5 times as likely as Gen X business owners to use these services. With the Millennial workforce quickly becoming the largest share of US workers, P2P seems to be thriving-and spurring a new generation of businesses.