Peer-to-peer (P2P) lending is one of the fastest-growing trends in the world of finance as more and more people start to turn to financial solutions alternative to banks’ offerings. They are drawn in by more competitive interest rates, the simplicity of accessing web-based services, and the collective nature of the P2P model. So, what actually is P2P lending? It is a business model which gives borrowers a chance to cut the middleman and solicit funds directly from potential investors, using a dedicated online platform.
How does P2P loans for businesses work?
Although P2P lending was started with the idea of connecting individual borrowers with individual lenders, many variations of such a model are becoming increasingly popular. Business lending, and in particular loans for Small and Medium Enterprises (SMEs), now form a sizeable bulk. An estimate by Cambridge Center for Alternative Finance(PDF) shows that P2P business lending was equivalent to 9.5% of total new loans issued to SMEs by UK banks in 2017 and even up to 29% if the size of a business is taken into account.
P2P business lending in the UK has been growing at an average annual rate of 48% between 2014 and 2018.
Source: British Business Bank ‘Small Business Finance Markets 2019/20’, available here.
Such popularity is, however, not without a reason.
Peer Loans vs Bank Loans: What are the perks of borrowing through Peer-to-Peer Lending Platforms?
How is borrowing from peers better than borrowing from traditional lenders? Is it better at all? We can identify three main perks that come with P2P loans: easy application process, low interest rates, and high availability.
First, P2P lending tends to be quicker and easier than going through traditional channels which often involve a long, tedious, and cumbersome due diligence process. This is particularly a problem for SMEs which often face cash flow problems and might have urgent needs to get over a temporary shortfall in capital. In the case of P2P lending, the red tape is much reduced and, on most P2P platforms, most loans get funded within no more than two weeks.
It is not only a fast but also a much easier and pleasant process. You can avoid trips to the bank, face-to-face appointments, and filling in multiple documents. Instead, P2P borrowers can get their loans approved from the comfort of their homes, using only the dedicated websites (or apps), which typically offer intuitive interfaces that are much easier to use and less intimidating.
Customers seem to realize this very clearly – 66% percent of Funding Circle’s borrowers (mostly SMEs), surveyed in 2019, had decided to apply for a P2P rather than a bank loan because they believed that the application would have taken too long and/or involved too much hassle.
Second, P2P loans tend to be cheaper and more transparent than bank loans. Interest rates are almost always lower, there are no hidden charges, and loans are flexible when it comes to prepayments (e.g. there are no prepayment or one-off payment charges). This is due to the simple fact that web-based P2P platforms do not have the same infrastructure costs as banks, meaning they can offer lower spreads and thus much more attractive rates to both lenders and borrowers.
Finally, it is much easier for SMEs to get a P2P loan. Lending to UK SMEs has markedly declined since the 2008 crisis. Due to relatively small loan values combined with high costs of application and processing, such loans are often simply not very profitable for the banks. Banks are especially likely to refuse loans for businesses with lower credit scores and/or those who struggle to provide a collateral for a loan (as many SMEs do).
Put simply, traditional financial institutions might just not be appropriate for SMEs’ finance needs in the first place. This concern, and the potentially crucial role of P2P lending in SME financing, has been recently realised at the policy-making level in the UK. Four P2P lending platforms have been approved for the Coronavirus Business Interruption Loan Scheme (CBILS) aiming to channel funds to SMEs and the self-employed.
P2P loan risks: Are P2P loans for UK companies safe?
In general, much of the risks involved in P2P lending lie with the investor. Once you convince lenders to finance your loan, there is little you have to worry about (except for your reputation and credit score in case you fail to pay back the loan). Nonetheless, there are a couple of concerns that each borrower needs to keep in mind when engaging in P2P lending, namely shaky regulation, eligibility of business to borrow money, and limited lender-borrower relationship.
First, P2P platforms are relatively new, which means there are few policies in place to control lending risk or ensure the stability and soundness of either party. In the UK, all reputable P2P platforms are regulated by the Financial Conduct Authority (FCA). Nonetheless, the regulatory framework is rather dynamic, and policies regarding, for example, the management of defaults, customer protection, and closure of platforms are still in early development stages and are likely to be evolving, thus potentially changing the P2P lending environment.
Furthermore, many P2P platforms, including the oldest UK’s platform – Zopa, restrict lending and borrowing to individuals and do not cater directly to SMEs. You can still borrow money for business development purposes, but you need to put your personal credit score on the line. In case of default, you can have a hard time accessing personal financial services from mainstream lenders in the future.
Finally, due to the collective lending approach, you borrow money from multiple and anonymous lenders, and thus, you are unable to build a long-term relationship. It is virtually the opposite of the know-your-customer approach adopted by banks, which, in the long run, can provide substantial benefits for established borrowers.
Steps to get a P2P loan and funding your business with P2P Lending
If you are convinced by the P2P financing model and want to go on with your first P2P loan, there are some tips you might want to consider along the two key steps you will have to take.
Step 1. Choose a credible platform that is right for you
Before committing to a P2P platform, check the Financial Services Register to make sure it is
approved by the FCA. You might also prefer platforms that explicitly target businesses to avoid
risking your personal credit score. Some of the most established UK platforms are:
- Funding Circle is the largest P2P lending platform in the UK and focuses specifically on
small business loans.
- ThinCats targets mid-sized companies with slightly larger loans than usually seen on the
- RateSetter is a complex platform serving individual as well as business loans and
remains one of the most popular choices in the UK since 2010.
Other than the credibility of the platform, you might look into other aspects such as ease of communication (user-friendliness of the website, support provided during the application, etc.), general terms at which your loan will be distributed, and eligibility (criteria you will need to meet to qualify for the loan at acceptable terms).
Step 2. Register and apply for a loan
After joining a selected platform, a borrower submits a loan application, which might include the following:
- A plan detailing how the money raised will be spent (e.g. in the form of a business plan);
- Evidence that your business is reputable and legitimate, e.g. financial and trading details
(e.g. bank statements);
- Any proof of your reliability/credit score, such as credit history and details of any existing debt.
First, the application will be reviewed by the platform representatives who will assess whether a loan application is viable, assign a risk score and credit rating to the application, and set the interest rate options. Once the application is approved by the review team, it will be published on the platform where it can be browsed and investigated by prospective lenders, who can then bid whatever sum they are willing to loan. After the listing ends, all loans will be consolidated and the funds transferred to you (provided that you have managed to draw in enough investors to finance the loan).
Nothing more to be done then other than making the money work to develop and strengthen