Since writing the article about different ways to raise capital for your business, I’ve been getting more and more questions about what this whole “peer to peer lending” thing is and how you can use it to finance your startup or small business.
Considering that Prosper, the first peer to peer lending company, only launched in 2006, there’s good reason that you haven’t heard the term yet – it isn’t mainstream!
But, LendingClub, the largest US p2p lending company out there, is now valued at upwards of $8 billion, meaning that it’s definitely something that you should be paying attention to.
So – What is peer to peer lending?
Traditional Lending Model
Most of us are familiar with bank loans, so let’s start there. When you get a loan from a bank, you are borrowing money from an institution with certain terms and conditions.
Likely, there is some kind of collateral, should you default on the loan, to ensure that the principle will be paid back. Remember bankers are risk-adverse, unless we’re talking about Wallstreet’s gambling problems.
In order to secure a loan from a bank for a business, you may need to provide a structured business plan, cash flow statements, and have a very specific reason for borrowing capital. If you are approved, you must pay interest on the capital that you receive until you pay back the loan.
One key part here is that banks are financial intermediaries, meaning that they are not letting you borrow their money. They are lending out the funds that have been deposited by their customers.
Well, not all of the funds. They need to keep a certain threshold in the bank at all times.
Ultimately, the difference between the interest rate they charge you and the small interest rate that they pay to their customers is their profit. Most of their expenses are in the form of employees, physical locations, and infrastructure.
Peer to Peer Lending Model
How does a p2p loan differ from a traditional bank loan? One word: Software.
A peer to peer lending platform functions as a marketplace with investors and borrowers. Their software will match investors up with your loan application. There is also no collateral, even if it’s a personal loan. Depending on your credit score, the term of the loan, and the type, you may experience a different APR (interest rate).
Because peer to peer lending platforms like Prosper and Lending Club use technology to connect lenders with borrowers, there is very little overhead and the websites can pass their savings on to you, facilitating lower interest rates.
Ironically, what originated as a “peer to peer” model is now attracting institutional investors. Lending Club’s CEO Renaud Laplanche underscores the importance of protecting retail investors on their platform, saying:
“We’ve been building lots of safeguards to ensure there is a great experience for all types of investors, including retail investors. The institutional investors we have at Lending Club are not credit hedgefunds–they’re long-term, patient investors: pension funds, insurance companies, endowments, foundations.
And they all have purchase limitations, that way we really know how much capital comes through the platform and we can manage it and make sure retail investors don’t get crowded out.”
What are the benefits of P2P Lending?
As an entrepreneur, there are a lot of benefits to this new lending model over the traditional banking model. Here are a few:
- Online application means a quicker approval time
- Fixed repayment rate
- No collateral needed
- No prepayment penalties
If you’re an investor, I think peer to peer lending is attractive because of the:
- Good returns
- Monthly cashflow
- Online investment management
- Easy ability to diversify
Where can you get started?
To get started, you can check out this list of different platforms out there, where you can obtain a loan or invest! Of this list, I recommend:
If you’re researching this new finance industry and want to set up your own lending platform, check out some of these tools.
