How peer-to-peer lending offers start-ups and small businesses a new funding option

If you need more finance to grow your business, there are a number of options to consider. You could turn to your own personal savings, ask family members for help, get a bank loan, issue shares, or speak to some business angels or venture capitalists. Or you could consider peer-to-peer (P2P) lending.

P2P lending is fast becoming the norm for businesses needing finance to get an idea off the ground or raise the capital necessary to expand and take projects to the next level.

But whilst it’s become a more common financial avenue for SMEs to pursue, it’s still not as well-known as it could be. According to a 2014 Nesta Report, only 44% of UK small businesses have heard of P2P lending.

So what exactly is peer-to-peer lending and how can small and growing businesses use it to finance growth?

What is peer-to-peer lending?

P2P lending is an alternative to traditional bank loans as a way for SMEs to borrow money to grow their business.

In the simplest terms, it removes the bank from the lending process.

Investors lend money to unrelated individuals or businesses – to peers – without the need to go through traditional financial institutions. As opposed to banks setting interest rates, these are often stipulated directly by lenders, or by lending platforms on their behalf.

Essentially, you’re borrowing money directly from people, instead of a company or an institution.

Where to get a P2P loan

Online P2P lending companies act as the intermediary, overseeing and facilitating the process, using a variety of different platforms, requirements, and credit checks.

Just like with banks, loans are available with diverse variations on terms and rates, and as always, the best advice is to look around and read the small print.

With lower overhead costs, intermediary P2P lending companies can provide services more cheaply than traditional financial institutions.

They fill all the functions of a bank, without lending their own money. The savings made are passed on to borrowers via lower interest rates, and to investors via higher returns.

There a number of P2P lending platforms, but as an SME, you need to look for a peer-to-business, (P2B) loan.

The first P2B lending platform was Funding Circle which launched in 2010. They’ve lent over £512 million to businesses since then. Other competitors are hot on their heels, with the likes of Assetz Capital and Thin Cats contributing to an industry growth of over 250% in the last two years, according to figures from the 2014 Nesta Report.

What are the benefits of a peer-to-business loan?

Recent government figures show that roughly half of SMEs are rejected the first time they apply for a business loan from a bank. This can be demoralising for new start-ups and frustrating for small businesses wishing to expand and means many businesses give up at an early stage.

That’s where peer-to-business (P2B) loans come in. They are a great alternative for businesses who might have been rejected for a bank loan for any number of reasons.

P2B offer businesses several advantages:

• They’re fast, with funds often available within the week
• They’re flexible, with loan terms ranging from 3 months up to 5 years
• They come from an established community of lenders, many of whom have been in the same position as the SMEs who are borrowing from them.

There’s also fixed rate borrowing on offer to lenders on a first come first served basis, as well as the peer to peer “norm” of lenders deciding how much they’d like to invest in a business and what rate of interest they’re looking for.

For many lenders, loan amounts range from £5,000 up to as much as £3 million, and there’s often no early repayment fee either.

Is it a credible addition to the high street banks?

Since 2014, the industry has seen regulation by the FCA. Lending companies must adhere to Principles for Business, preparations must be in place in case any platform should go under, and all conduct is monitored and reviewed.

The additional confidence and faith in the security of P2P/P2B lending is evidenced by the continued growth of the industry.

How does P2B compare with bank loans?

For the borrower, in many ways getting a peer-to-business loan is a similar process to getting a normal bank loan. Credit is checked by a credit reference agency, often alongside the additional requirements of many lending platforms.

But because banks have been more averse to risk since the credit crunch, many traditional financial lenders are still conservative about who they will lend money to, and the rates they will charge.

Stringent regulations are also commonplace in many big banks due to their size, and there are specific rules and guidelines which must always be followed. That means very little room for flexibility and negotiation.

Increasingly banks are working with P2P lenders, referring customers to them if they are better placed to offer more appropriate funding.

What are the drawbacks of a peer-to-business loan?

Whilst P2B lending does have a lot of benefits, there are still a few disadvantages to consider:

• It’s still not a place to turn to if your credit isn’t great.
• Interest rates can be more expensive than banks, typically around the 7%-10% mark.
• Upfront arrangement fees can be expensive, sometimes in excess of 5% of the amount you need to borrow.

It’s really important to take all the fees into account when comparing the overall cost of the finance. Your bank might charge you a higher rate of interest but lower arrangement fees, and vice versa.

What about as an investor?

If you have cash you wish to invest as another way of generating money for your SME, things can get a little more complicated.

Lending money via a P2P platform is treated as an investment, so there is less protection on your money and greater risk of loss. You’re not covered by any FSCS guarantees.

But, returns are typically 3-6% overall, higher than traditional investment routes at the moment.

You need to check the past track record of the P2P platform you’re going to use, including how much money has been written off in bad debts so far, and over what timeline.

Remember, you have the opportunity to choose the level of risk you’re happy with and how long you’d like your money tied up for. There are annual fees to pay, so you need to look at the overall return after these fees have been paid and weigh this up against the risk you are taking.

The Government is also in consultations at the moment considering a P2P ISA, so investors could benefit from tax free interest in the future.

Is a P2B loan suitable for my small business?

It’s not an easy question to answer as it depends greatly on individual circumstances, but it’s definitely a route that should be investigated and weighed up against other more traditional financial avenues.

The good news is that there has been a substantial upturn in high street banks lending money too.

But if you’re struggling to get a bank loan and are not sure where else to turn to raise capital, it could be a good idea to speak to your accountant about P2B lending.

With increased government support on ISA inclusion, continued FCA oversight (without being stifling) and further banking partnerships, peer-to-peer or peer-to-business lending could be the way forward for many SMEs, and it’s certainly a worthy option to consider.

This guide has been written for ByteStart by Mandy Mitten, Director of Mitten Clarke the award-winning, leading Chartered Accountancy firm in Stoke-on-Trent, Staffordshire.