How P2P Lending Works for Business Owners Seeking Funds
The U.S. peer-to-peer (P2P) lending market was valued at $26.3 billion in 2023 and is expected to grow to $270.4 billion by 2033. First popular with consumers, businesses are now beginning to access this new type of loan because of the speed of the online application process and the often competitive interest rates.
Read on to discover what P2P lending is, when and why companies use it, how to apply for a P2P loan, and what alternatives are available.
What Is P2P Lending?
P2P lending is when loans are funded by individuals (or by institutional investors like hedge funds and asset managers). This is different from standard consumer and business loans, which are funded by traditional financial institutions like banks and credit unions.
For-profit P2P lending platforms are subject to SEC regulations. Some platforms only allow accredited individual investors to participate, while others like Prosper allow retail/individual investors to participate, subject to their state’s financial suitability requirements.
How Does P2P Lending Work?
You can apply for P2P lending on specialist online peer-to-peer financing platforms. This is how borrowers and investors are matched up together.
When an investor registers on a P2P platform, they indicate the level of loan risk they're comfortable with and are interested in backing.
Some investors will only want to back low-risk loans — loans with the lowest likelihood of a borrower default. Some investors want higher-risk loans — loans where borrowers are more likely to default. For that increased risk, investors expect a greater return on their investment. That greater return comes in the form of higher interest rates applied to riskier loans.
This is where the platform comes in. When you make a P2P loan application, they’ll determine how risky it is to lend to you.
They’ll then offer investors the opportunity to fund your loan. On the platform, potential investors will see how much you want to borrow, the purpose of the loan, the risk rating, and the interest rate being charged. While some lenders want to make a decision on each loan individually, others give the platform permission to use their capital to fund any proposal that meets their risk requirements.
To protect their capital, there may be a handful or even dozens of investors funding your loan. Investors often spread risk by backing multiple loans instead of just a handful. By offering investors this flexibility, the P2P platform is more likely to be able to fulfill your loan request.
If the platform is successful in securing your funding, you as the borrower must decide if you’re happy with the interest rate you’ve been offered. If you are, you agree to the loan contract, and then the capital is transferred to your bank account.
You then make monthly repayments on the facility over the length of time agreed. The loan is terminated on the last payment.
What Do Companies Use Peer-to-Peer Loans to Fund?
Companies apply to P2P lenders for the same reasons they apply to banks and credit unions for funding.
Those reasons include but aren’t limited to:
Cash flow management: Access to capital during slower sales periods enables companies to manage their money better and meet their financial commitments like rent, payroll, and taxes.
Equipment purchase: Traditional equipment finance sometimes requires borrowers to provide a deposit of 20% of the value of the asset. There’s no such requirement with P2P lending.
Expansion costs: Banks and credit unions can be reluctant to fund expansion because your fixed costs increase before your revenue does. This is a level of risk that P2P investors seeking greater rewards may be more comfortable with.
Real estate costs: Firms moving into new premises can take out a P2P loan to renovate the property in order to attract more customers. Other firms might choose bridge financing for this use case instead.
Order inventory: Wholesalers and suppliers often offer deep discounts on volume or end-of-line orders. P2P funding gives companies the finance they need to take advantage of these deals.
Why Do Businesses Choose P2P Loans Over Traditional Loans?
There are many reasons small business owners choose peer-to-peer lending over traditional bank and credit union loans.
Borrowers with good credit scores or excellent credit scores may be offered a lower interest rate than they’d get from standard lenders. This reduces the amount companies have to pay back over the course of their loan.
At the same time, borrowers with poor or fair credit scores and short credit histories are more likely to be approved for a loan, as are startups. In fact, many lenders will let you know what your chances of being approved for your loan are without having to run a hard credit check. Multiple hard credit checks may knock your credit score down. If you keep up your repayments on a P2P loan, your credit score may improve, meaning you’ll have more borrowing options available to you in the future.
Compared with other financial services providers, there is a high degree of automation in approving loans and matching proposals to specific investors. This means that borrowers can often be funded quickly, or even the next day.
Most P2P loans are also unsecured meaning that you don’t have to risk your personal or business assets to be approved.
What Are the Downsides to P2P Finance?
While there is much to recommend P2P lending, there are a number of significant trade-offs.
Although it’s great news for borrowers with bad credit scores that their creditworthiness is not as important to P2P lenders, they will pay higher interest rates on their facilities. You may be offered a lower rate on a secured P2P loan however. This means you could lose your collateral if you default on your loan.
Aside from the interest, you may also be subject to other P2P loan charges, like an origination fee. There may also be late fees if you don’t make a repayment on time and prepayment penalties if you pay off your loan early. Be sure to look into all the potential fees to understand the true cost of the loan.
Lastly, if you fall into arrears, you may find that your P2P provider is unable to alter your loan terms to provide you with breathing space. They may also be quicker to call in debt collection agencies. Other lenders, such as banks or credit unions, may be more willing to work with you to help you avoid defaulting on your loan.
How Do I Apply for Peer-to-Peer Loans?
All P2P lenders are online lenders, so the best place to start will be the platform’s website.
Your lender will want to know how much you want to borrow, how long of a term you want to repay the loan, and what the funds will be used for. They’ll also require information about you as the owner — including your name, where you live, and your contact details. Some may ask for business or financial details, such as annual revenue, number of employees, or your credit score. This might be your business credit score or your personal FICO Score.
Alternatives to Peer-to-Peer Loans
Four other finance and loan options to consider other than P2P lending are:
Traditional bank loans: These types of loans are available from banks and credit unions. However, banks often have much higher eligibility criteria than P2P funders.
Credit cards: You can charge business expenses on a credit card. However, interest rates are often much higher than P2P loans and other funding options, leading to credit card debt that can be hard to pay off.
Personal loan: The best personal loans offering the lowest interest rates are generally restricted to borrowers with high credit scores. Mixing business finance and personal finance can also make bookkeeping and accounting more difficult.
Bridge loans: If you have a temporary shortfall in cash, you can use a bridge loan to provide the capital you need until you receive funding from suppliers or other lenders.
Business lines of credit: Like with a credit card, a business line of credit allows you to borrow up to a predetermined limit. Every time you pay down the balance partly or in full, that money becomes available to borrow again.
Working capital advances: You can cover day-to-day operational costs like rent and payroll with a working capital advance when cash flow is tight.
Get the Right Funding for Your Business
P2P lending is best known for providing competitively priced unsecured personal loans to consumers. However, a growing number of businesses are taking advantage of it to fund expansion, plug gaps in cash flow, renovate their offices, and more.
P2P lenders can fund proposals very quickly. For borrowers with good credit scores, the interest rates are competitive. But borrowers with poor credit scores may be able to access the capital they need when they would otherwise be refused by their bank or credit union.
But P2P lending might be the right option for your business. Backd offers two alternative financing opportunities, and the funds can be in your bank account as soon as tomorrow. Find out more about our:
Business line of credit: Borrow up to $750,000 and draw down funds only when you need them.
Working capital advance: Access up to $2 million with flexible repayment terms of up to 16 months.
Apply today for the capital you need.
