If you own a small business, it may come as no surprise that bank loans are tougher to come by. However, other avenues for small business financing are opening up.
Last month, the largest peer-to-peer (P2P) lenders, Lending Club and Prosper, originated more than $280 million in loans. The increased popularity of P2P/online consumer lending has been well-documented; P2P lending expert Peter Renton with Lend Academy estimates that these platforms have issued more than $3.4 billion in mostly personal loans since 2006.
The next natural step for the industry? Extension to the small business sector. As banks maintain a tight hold on cash, P2P offers fast and convenient access to capital for qualified small business owners.
In the current landscape, P2P has emerged as a solid middle ground for small businesses seeking an alternative to credit cards and the pricier merchant cash advance, though even these expensive financing options have dramatically increased in popularity as well.
This expansion of P2P into small business lending represents a natural progression for the industry, given lending trends since even before the Great Recession. As the Cleveland Federal Reserve Bank has reported, bank lending to small businesses has been on a downward spiral since the late ’90s.
The success of Lending Club and Prosper has established a foundation of credibility for borrowers and lenders alike. Restricted lending by banks during the recession due to fewer creditworthy companies is a direct contributor to the rise of these platforms, and alternative lending in general. Since the demand for capital is strong, industry experts anticipate small business owners will gravitate to P2P in pursuit of short-term cash infusions.
Greater Access for Small Business Owners
The development of evolving technologies aimed at the evaluation of potential borrowers has facilitated the rise of small business P2P loans as well. Access to Big Data, and the development of refined computer algorithms, enables online lending platforms to identify viable applicants within minutes.
QuarterSpot, a small business P2P lender, has built its platform around precisely this type of technology. As CEO Adam Cohen explains, his company utilizes a complex formula that targets highly specific criteria, searches out red flags and ultimately evaluates loan applications efficiently and cost-effectively.
Actually, the word “application” is being used very loosely here. One of the touted benefits of P2P small business lending is that it requires very little paperwork. Working from five basic pieces of information, QuarterSpot obtains credit reports and bank transaction histories for potential borrowers. Businesses that meet the established criteria can have loans processed immediately. You don’t need to put up a house, car or personal savings in order to secure the transaction. In some cases, approved applicants may have fresh capital in hand within 24 hours.
As for the rates, QuarterSpot, for example, offers some good options, particularly in comparison to merchant cash advances. Whereas the latter require payment on full principal, QuarterSpot’s amortized loans break payments down into smaller chunks, including daily segments. This means that as the loan is paid down, interest is paid on the reduced amount as opposed to the original principal. Considering that online small business loans generally offer better interest rates than merchant cash advances to begin with, amortization only sweetens the deal.
How P2P Sees Small Businesses
The trends that led to the expansion of P2P/online lending into the small business sector are further reflected in the success of IOU Central. As CEO Phil Marleau points out, the emphasis on technology is a driving factor in the rapid growth of his company. IOU Central’s underwriting model was years in the making, encompassing everything from credit scores and bank records to social media feedback and street views of business locations. With 15% to 20% of applicants receiving loans and a default rate under 5%, the system seems to be working.
Marleau emphasizes that P2P lenders are much more nimble than traditional banks. Whereas banks are notorious for their bias against certain types of businesses like restaurants or motels, IOU Central, for example, bases their decisions on a different set of criteria. They do not evaluate industries, but evaluate individual businesses on merit. Unlike other points on the lending spectrum, such as factoring companies, they are invested in the success of the businesses they lend to. This dynamic serves to increase the flow of small business borrowers towards P2P lenders.
Even the banks themselves seem to be acknowledging the entrance of companies like IOU Central and QuarterSpot into the small business-lending sector. As Marleau indicates, banks are often reluctant to do the kind of microanalysis necessary to evaluate certain types of small business applications. In such cases, rather than alienate a potential future customer, banks will actually refer them along to P2P lenders who might be more likely to meet their needs.
With this type of collaborative relationship emerging in conjunction with a slew of other economic developments, P2P may continue to grow as a viable financing option for more small businesses.
Image: diego cervo