Peer to peer lending has gained popularity in recent years since banks have cut down on loans to small businesses. In its most basic sense, peer to peer lending is a type of loan that takes place between individuals and organizations without any involvement from traditional banks.
However, there are a few similar concepts like crowdfunding and online lending that are also becoming more prevalent in the small business space. While these do share some similarities with peer to peer lending, there are some major differences to consider as well. Here’s what you need to know.
What Is Peer to Peer Lending?
Peer to peer loans are normally facilitated online. Platforms like Prosper offer a place where businesses or individuals looking for money can connect with investors. The benefit to the lender is a higher rate of return on their investment. And the benefit to the borrower is the ability to borrow at more favorable terms than they might find from a traditional bank.
Difference Between Peer to Peer Lending and Crowdfunding
Crowdfunding platforms like Kickstarter and GoFundMe also allow businesses or individuals to access capital for their business without having to go through traditional banks. However, in those instances you normally accept donations from multiple investors in exchange for either equity in the business or some kind of reward. So you either have to give up some shares of your company or facilitate the delivery of prizes for those who have donated.
On the other hand, peer to peer lending functions a bit more like a traditional loan. You still have a specific period of time where you have to repay the loan to the lender. You pay back the entirety of what you borrowed, plus interest, over the agreed-upon term. But you give up no equity in your business.
Difference Between Peer to Peer Lending and Microloans
There are also online platforms like Grameen aimed at helping entrepreneurs and individuals access microloans. These are usually targeted toward those without much access to financing or resources. As such, the original purpose of these loans was more about spurring developing economies than bringing in a financial return for investors. However, some do now offer more fiscal benefits for all parties.
These loans are usually very small. So businesses or individuals may need to piece together multiple microloans to accomplish a particular goal. In addition, Grameen and some other microloan providers are financial institutions that also offer other services aside from microloans.
How Can Small Businesses Use Peer to Peer Lending?
Peer to peer lending offers several potential benefits to entrepreneurs, especially for those who need smaller loans or have to access money quickly. You start by finding a platform where you can list your business and needs so potential investors can connect with you. These investors will have access to your credit and financial information as well, so they can make the proper decision for their own financial wellbeing. So if you have poor or no credit, it still may not work for your business.
Often, investors will spread out their money into smaller investments to minimize risk. So you’ll likely need to attract multiple investors to completely fund your startup or project. There’s also no guarantee that enough investors will select your business. But if they do, you may be able to access the money in just a couple of weeks.
If your credit is good and you only need a small amount of money, you may be able to get a loan on more favorable terms than you would from a traditional bank, since banks also need to factor in their own operating costs into your interest rate and fees. So it’s an option that’s worth looking into for select businesses. But you should consider other financing options carefully as well.