Peer-to-peer lending helps small businesses

Capital is critical to launching and growing a small business. Yet, getting a bank loan can be a frustrating and often fruitless process.

 

As credit became more difficult to obtain during the downturn, many entrepreneurs tapped into alternative financing such as microloans, peer-to-peer lending and crowdfunding. Banks have since eased lending terms, but business owners are still exploring non-traditional financing.

 

With some research, entrepreneurs can find unexpected loan providers, business grants, online lists of angel investors and business plan competitions that dole out cash prizes.

 

"A whole bunch of options have opened up," says Paul Kedrosky, a senior fellow at Ewing Marion Kauffman Foundation, where he focuses on entrepreneurship, innovation and capital markets. "People have gotten much more comfortable with providing and receiving capital in new ways."

 

In the peer-to-peer and crowdfunding areas, lenders and borrowers never have to meet face-to-face. Transactions are done online.

 

Peer-to-peer sites connect individual borrowers with lenders and take a fee for the service. Lending Club, for instance, takes a 2% to 5% cut for "providing the services of screening borrowers and issuing the loans."

 

Lending Club borrowers apply online through a free application process. They supply financial information, background details and explain why the funds are needed (i.e., to start a business or pay off credit card debt).

Most applicants don't get their loans funded — 26,740 loans have been accepted, and 267,194 have been declined — but those who do get the money quickly. Usually, cash is deposited in the borrower's bank account within 10 days of an application's acceptance.

 

Crowdfunding sites usually pool a large number of small loans or donations. The sites vary, but one of the most known, Kickstarter.com, posts details on creative projects that range from producing a movie to opening a vegan restaurant.

 

Backers don't get their money back or interest. Instead they receive a "reward" such as a DVD of the movie produced.

 

"We shy away from the word 'donation,'" says Kickstarter co-founder Yancey Strickler. "In a sense, this is commerce. You get something in return."

 

Kickstarter has an all-or-nothing approach. If a money-seeker doesn't meet his or her stated fundraising goal, no funding is given and backers aren't charged.

 

"It's a good way to know if the idea has value or not," Strickler says.He adds that it's also "hard to complete a project on an incomplete budget."

 

Some folks back a project because they know the money-seeker or run in the same circles as that person. Others want to get involved with cool initiatives.

 

And there are also those who feel an affinity for the project after reading the back story online. Backers get "that warm and fuzzy feeling" when supporting someone's dreams, Strickler says.

 

About 43% of Kickstarter initiatives are successfully funded. The firm takes a 5% cut from successful projects and uses Amazon Payments to funnel the rest to the cash-seeker's bank account.

In the two years since Kickstarter's launch, close to 592,000 people have helped to back more than 7,500 successful projects.

 

Read about more sites and hear how businesses used them here.